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Dynamic Trading and Asset Prices: Keynes vs. Hayek

  • Giovanni Cespa
  • Xavier Vives

We investigate the dynamics of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model with long-term investors. We argue that the fact that prices can score worse or better than consensus opinion in predicting the fundamentals is a product of endogenous short-term speculation. For a given, positive level of residual payoff uncertainty, if noise trade displays low persistence rational investors act like market makers, accommodate the order flow, and prices are farther away from fundamentals compared to consensus. This defines a “Keynesian” region; the complementary region is “Hayekian” in that rational investors chase the trend and prices are systematically closer to fundamentals than average expectations. The standard case of no residual uncertainty and noise trading following a random walk is on the frontier of the two regions and identifies the set of deep parameters for which rational investors abide by Keynes’ dictum of concentrating on an asset “long term prospects and those only.” The analysis explains how accommodation and trend chasing strategies differ from momentum and reversal phenomena because of the different information sets that investors and an outside observer have.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2009/wp-cesifo-2009-10/cesifo1_wp2839-rev.pdf
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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2839.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2839
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  13. Manzano, Carolina & Vives, Xavier, 2010. "Public and private learning from prices, strategic substitutability and complementarity, and equilibrium multiplicity," IESE Research Papers D/874, IESE Business School.
  14. Luis Angel Medrano & Xavier Vives, 2004. "Regulating Insider Trading When Investment Matters," Review of Finance, Springer, vol. 8(2), pages 199-277.
  15. Xavier Vives, 2007. "Information and Learning in Markets," Levine's Bibliography 122247000000001520, UCLA Department of Economics.
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  25. Franklin Allen & Stephen Morris & Hyun Song Shin, 2006. "Beauty Contests and Iterated Expectations in Asset Markets," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 719-752.
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