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Expectations, Liquidity, and Short-term Trading

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  • Giovanni Cespa
  • Xavier Vives

Abstract

We consider a two-period market with persistent liquidity trading and risk averse privately informed investors who have a one period horizon. With persistence, prices reflect average expectations about fundamentals and liquidity trading. Informed investors engage in “retrospective” learning to reassess the inference about fundamentals made at the early stage of the trading game. This introduces strategic complementarities in the use of information and can yield two stable equilibria which can be ranked in terms of liquidity, volatility, and informational efficiency. We establish the limits of the beauty contest analogy for financial markets and derive a rich set of implications to explain market anomalies, and empirical regularities.

Suggested Citation

  • Giovanni Cespa & Xavier Vives, 2011. "Expectations, Liquidity, and Short-term Trading," CESifo Working Paper Series 3390, CESifo.
    • Handle: RePEc:ces:ceswps:_3390
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    More about this item

    Keywords

    price speculation; multiple equilibria; average expectations; public information; momentum and reversal; Beauty Contest;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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