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Rational trader risk

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  • Kondor, Peter

Abstract

Allowing for a richer information structure than usual, we show that rational traders’ calculation with short-term price fluctuations may heavily influence their behaviour even if the interim price is not influenced by non-rational agents i.e. there is no noise trader risk. Instead, traders expect that new rational entrants with different information in the interim period will drive the price against them. Consequently, rational traders in the first period will hesitate to trade on their private information or - in the extreme - will trade against their private information i.e. buy more of the risky asset when they consider it worse. In the first part we develop a microstructure model with learning where the above effect will result in severe inefficiency and mispricing. In the second part, we discuss the critical properties of the information structure which are expected to result in similar findings in general models.

Suggested Citation

  • Kondor, Peter, 2004. "Rational trader risk," LSE Research Online Documents on Economics 24646, London School of Economics and Political Science, LSE Library.
  • Handle: RePEc:ehl:lserod:24646
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    File URL: http://eprints.lse.ac.uk/24646/
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    Cited by:

    1. Giovanni Cespa & Xavier Vives, 2012. "Dynamic Trading and Asset Prices: Keynes vs. Hayek," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(2), pages 539-580.
    2. Péter Kondor, 2009. "The more we know, the less we agree: Higher-order expectations and public announcements," 2009 Meeting Papers 1018, Society for Economic Dynamics.
    3. Cai, Charlie X. & McGuinness, Paul B. & Zhang, Qi, 2011. "The pricing dynamics of cross-listed securities: The case of Chinese A- and H-shares," Journal of Banking & Finance, Elsevier, vol. 35(8), pages 2123-2136, August.

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    More about this item

    Keywords

    rare events; rare eisasters; equity premium puzzle; generalized empirical Likelihood; semi-parametric Bayesian Inference; calibration; cross-section of asset;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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