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Rational destabilising speculation and the riding of bubbles

  • R. Andergassen

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.

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Paper provided by Dipartimento Scienze Economiche, Universita' di Bologna in its series Working Papers with number 475.

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Date of creation: 2003
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Handle: RePEc:bol:bodewp:475
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  1. Andrei Shleifer & Robert W. Vishny, 1995. "The Limits of Arbitrage," NBER Working Papers 5167, National Bureau of Economic Research, Inc.
  2. 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.
  3. James Dow & Gary Gorton, . "Arbitrage Chains," Rodney L. White Center for Financial Research Working Papers 6-93, Wharton School Rodney L. White Center for Financial Research.
  4. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Scholarly Articles 27693805, Harvard University Department of Economics.
  5. Brunnermeier, Markus K., 2001. "Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding," OUP Catalogue, Oxford University Press, number 9780198296980, December.
  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. Hart, Oliver D. & Kreps, David M., 1986. "Price Destabilizing Speculation," Scholarly Articles 3448679, Harvard University Department of Economics.
  8. Shleifer, Andrei, 2000. "Inefficient Markets: An Introduction to Behavioral Finance," OUP Catalogue, Oxford University Press, number 9780198292272, December.
  9. Franklin Allen & Gary Gorton, 1993. "Churning Bubbles," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 813-836.
  10. 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.
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