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Positive Feedback Investment Strategies and Destabilizing Rational Speculation

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Author Info
J. Bradford De Long
Andrei Shleifer
Lawrence H. Summers
Robert J. Waldmann

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Abstract

Analyses of the role of rational speculators in financial markets usually presume that such investors dampen price fluctuations by trading against liquidity or noise traders. This conclusion does not necessarily hold when noise traders follow positive-feedback investment strategies buy when prices rise and sell when prices fall. In such cases, it may pay rational speculators to try to jump on the bandwagon early and to purchase ahead of noise trader demand. If rational speculators' attempts to jump on the bandwagon early trigger positive-feedback investment strategies, then an increase in the number of forward-looking rational speculators can lead to increased volatility of prices about fundamentals.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2880.

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Date of creation: Mar 1989
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Publication status: published as Journal of Finance, Vol. 45, No. 2, (June 1990), pp. 374-97.
Handle: RePEc:nbr:nberwo:2880

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  1. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September. [Downloadable!] (restricted)
  2. Hart, Oliver D & Kreps, David M, 1986. "Price Destabilizing Speculation," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 927-52, October. [Downloadable!] (restricted)
  3. Hart, Oliver D, 1977. "On the Profitability of Speculation," The Quarterly Journal of Economics, MIT Press, vol. 91(4), pages 579-97, November. [Downloadable!] (restricted)
  4. John Y. Campbell & Albert S. Kyle, 1988. "Smart Money, Noise Trading and Stock Price Behavior," NBER Technical Working Papers 0071, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Stein, Jeremy C, 1987. "Informational Externalities and Welfare-Reducing Speculation," Journal of Political Economy, University of Chicago Press, vol. 95(6), pages 1123-45, December. [Downloadable!] (restricted)
  6. Robert J. Shiller & Karl E. Case, 1988. "The Behavior of Home Buyers in Boom and Post-Boom Markets," Cowles Foundation Discussion Papers 890, Cowles Foundation, Yale University. [Downloadable!]
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  7. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April. [Downloadable!] (restricted)
  8. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November. [Downloadable!] (restricted)
  9. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 1(1), pages 41-66. [Downloadable!] (restricted)
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  10. Leland, Hayne & Rubinstein, Mark, 1988. "Comments on the Market Crash: Six Months After," Journal of Economic Perspectives, American Economic Association, vol. 2(3), pages 45-50, Summer. [Downloadable!] (restricted)
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