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Trading Frenzies and Their Impact on Real Investment

Listed author(s):
  • Goldstein, Itay
  • Ozdenoren, Emre
  • Yuan, Kathy

We study a model where a capital provider learns from the price of a firm’s security in deciding how much capital to provide for new investment. This feedback effect from the financial market to the investment decision gives rise to trading frenzies, where speculators all wish to trade like others, generating large shifts in prices and firms’ investments. Coordination among speculators is sometimes desirable for price informativeness and investment efficiency, but speculators’ incentives push in the opposite direction, so that they coordinate exactly when it is undesirable. We analyze the determinants of coordination among speculators and study policy measures that affect patterns of coordination to improve price informativeness and investment efficiency.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7652.

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Date of creation: Jan 2010
Handle: RePEc:cpr:ceprdp:7652
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