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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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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
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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. Eichberger, J. & Kelsey, D., 1993. "Uncertainty Aversion and Dynamic Consistency," Discussion Papers 93-08, Department of Economics, University of Birmingham.
  3. 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.
  4. Sarin, Rakesh K & Wakker, Peter, 1992. "A Simple Axiomatization of Nonadditive Expected Utility," Econometrica, Econometric Society, vol. 60(6), pages 1255-72, November.
  5. V. V. Chari & Patrick J. Kehoe, 2003. "Financial crises as herds: overturning the critiques," Staff Report 316, Federal Reserve Bank of Minneapolis.
  6. Sushil Bikhchandani & David Hirshleifer & Ivo Welch, 2010. "A theory of Fads, Fashion, Custom and cultural change as informational Cascades," Levine's Working Paper Archive 1193, David K. Levine.
  7. 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.
  8. Kelsey, D., 1993. "Dutch Book Arguments and Learning in a Non-Expected Utility Framework," Discussion Papers 93-03, Department of Economics, University of Birmingham.
  9. David Schmeidler, 1989. "Subjective Probability and Expected Utility without Additivity," Levine's Working Paper Archive 7662, David K. Levine.
  10. Vives, Xavier, 1996. "Social learning and rational expectations," European Economic Review, Elsevier, vol. 40(3-5), pages 589-601, April.
  11. 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.
  12. Hirshleifer, David & Teoh, Siew Hong, 2001. "Herd Behavior and Cascading in Capital Markets: A Review and Synthesis," MPRA Paper 5186, University Library of Munich, Germany.
  13. Gilboa, Itzhak, 1987. "Expected utility with purely subjective non-additive probabilities," Journal of Mathematical Economics, Elsevier, vol. 16(1), pages 65-88, February.
  14. Tallon, Jean-Marc, 1998. "Asymmetric Information, Nonadditive Expected Utility, and the Information Revealed by Prices: An Example," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(2), pages 329-42, May.
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