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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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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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  1. Dimitri Vayanos & Paul Woolley, 2008. "An Institutional Theory of Momentum and Reversal," FMG Discussion Papers dp621, Financial Markets Group.
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  17. Vives, Xavier, 1997. "Learning from Others: A Welfare Analysis," Games and Economic Behavior, Elsevier, vol. 20(2), pages 177-200, August.
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  25. Manzano, Carolina & Vives, Xavier, 2010. "Public and Private Learning from Prices, Strategic Substitutability and Complementarity, and Equilibrium Multiplicity," CEPR Discussion Papers 7949, C.E.P.R. Discussion Papers.
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