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Rational destabilising speculation and the riding of bubbles

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  • R. Andergassen

Abstract

We present a model where it can be optimal for rational informed speculators/arbitragers to ride the bubble instead of using their information for stabilising purposes. This result stems from the interaction of speculators with behavioural traders. These latter in each period of time either discover the true fundamental value of the asset, or use a positive feedback strategy. We study the equilibrium strategy profiles of speculators in the case of short and long horizons and derive the resulting average expected excess deviation of the asset price. Further we consider the possibility of market manipulation and its consequences on the market efficiency.

Suggested Citation

  • R. Andergassen, 2003. "Rational destabilising speculation and the riding of bubbles," Working Papers 475, Dipartimento Scienze Economiche, Universita' di Bologna.
  • Handle: RePEc:bol:bodewp:475
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    References listed on IDEAS

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    1. Hart, Oliver D & Kreps, David M, 1986. "Price Destabilizing Speculation," Journal of Political Economy, University of Chicago Press, vol. 94(5), pages 927-952, October.
    2. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-395, June.
    3. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
    4. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
    5. Dow, James & Gorton, Gary, 1994. " Arbitrage Chains," Journal of Finance, American Finance Association, vol. 49(3), pages 819-849, July.
    6. Abreu, Dilip & Brunnermeier, Markus K., 2002. "Synchronization risk and delayed arbitrage," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 341-360.
    7. Brunnermeier, Markus K., 2001. "Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding," OUP Catalogue, Oxford University Press, number 9780198296980.
    8. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272.
    9. Franklin Allen & Gary Gorton, 1993. "Churning Bubbles," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 813-836.
    10. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336.
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