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Ambiguity in Financial Markets: Herding and Contrarian Behaviour

  • J L Ford, David Kelsey and W Pang

The paper studies the impact of ambiguity on history-dependant beahviour in the standard microstructure model of financial markets. We show that differences in ambiguity attitudes between market makers and traders can generate contrarian and herding behaviour in stock markets where assets are traded sequentially and trading prices are endogenously determined. We also show the mispricing can be only short-term, and in the long-run market is efficient in the sense that the market price aggregates information without distortions.

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File URL: ftp://ftp.bham.ac.uk/pub/RePEc/pdf/herd-finalmay05.pdf
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Paper provided by Department of Economics, University of Birmingham in its series Discussion Papers with number 05-11.

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Length: 41 pages
Date of creation: May 2005
Date of revision:
Handle: RePEc:bir:birmec:05-11
Contact details of provider: Postal:
Edgbaston, Birmingham, B15 2TT

Web page: http://www.economics.bham.ac.uk

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  1. Jean-Paul Decamps & Stefano Lovo, 2002. "Risk Aversion and Herd Behavior in Financial Markets," Working Papers hal-00593657, HAL.
  2. Chari, V. V. & Kehoe, Patrick J., 2004. "Financial crises as herds: overturning the critiques," Journal of Economic Theory, Elsevier, vol. 119(1), pages 128-150, November.
  3. Jean-Marc Tallon, 1998. "Asymmetric Information, Nonadditive Expected Utility, and the Information Revealed by Prices: An Example," Post-Print halshs-00502491, HAL.
  4. Kilka, Michael & Weber, Martin, 1998. "What Determines the Shape of the Probability Weighting Function under Uncertainty?," Sonderforschungsbereich 504 Publications 98-11, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
  5. Kelsey, D., 1993. "Dutch Book Arguments and Learning in a Non-Expected Utility Framework," Discussion Papers 93-03, Department of Economics, University of Birmingham.
  6. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
  7. Vives, Xavier, 1996. "Social learning and rational expectations," European Economic Review, Elsevier, vol. 40(3-5), pages 589-601, April.
  8. Gilboa, Itzhak, 1987. "Expected utility with purely subjective non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 16(1), pages 65-88, February.
  9. Sarin, Rakesh K & Wakker, Peter, 1992. "A Simple Axiomatization of Nonadditive Expected Utility," Econometrica, Econometric Society, vol. 60(6), pages 1255-72, November.
  10. Eichberger, Jurgen & Kelsey, David, 1996. "Uncertainty Aversion and Dynamic Consistency," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(3), pages 625-40, August.
  11. David Hirshleifer & Siew Hong Teoh, 2003. "Herd Behaviour and Cascading in Capital Markets: a Review and Synthesis," European Financial Management, European Financial Management Association, vol. 9(1), pages 25-66.
  12. Wakker, Peter P, 2001. "Testing and Characterizing Properties of Nonadditive Measures through Violations of the Sure-Thing Principle," Econometrica, Econometric Society, vol. 69(4), pages 1039-59, July.
  13. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  14. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, vol. 100(5), pages 992-1026, October.
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