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Dynamic trading and asset prices: Keynes vs. Hayek

  • Cespa, Giovanni

    (Queen Mary University of London)

  • Vives, Xavier

    ()

    (IESE Business School)

We investigate the dynamic of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model. We look at the bias of prices as estimators of fundamental value in relation to traders' average expectations and note that prices are more (less) biased than average expectations if and only if traders over- (under-) rely on public information with respect to optimal statistical weights. We find that prices are biased in relation to average expectations whenever traders speculate on short-run price movements. In a market with long traders, over-reliance on public information obtains if noise trader increments are correlated enough and/or there is low enough residual uncertainty in the payoff. This defines a "Keynesian" region; the complementary region is "Hayekian" in that prices are less biased than average expectations in the estimation of fundamental value. The standard case of no residual uncertainty and noise trading following a random walk is on the frontier of the two regions. With short-term traders there typically are two equilibria, with the stable (unstable) one displaying over (under-) reliance on public information.

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Paper provided by IESE Business School in its series IESE Research Papers with number D/716.

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Length: 51 pages
Date of creation: 09 Nov 2007
Date of revision:
Handle: RePEc:ebg:iesewp:d-0716
Contact details of provider: Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
Web page: http://www.iese.edu/
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  2. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
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  8. Giovanni Cespa & Thierry Foucault, 2008. "Insiders-Outsiders, Transparency and the Value of the Ticker," Working Papers 628, Queen Mary University of London, School of Economics and Finance.
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  13. Vives, X., 1993. "Short-Term Investment and the Informational Efficiency of the Market," UFAE and IAE Working Papers 207.93, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
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