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Rational Trader Risk


  • Péter Kondor


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

  • Péter Kondor, 2005. "Rational Trader Risk," FMG Discussion Papers dp533, Financial Markets Group.
  • Handle: RePEc:fmg:fmgdps:dp533

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    References listed on IDEAS

    1. Bruno Biais & Peter Bossaerts, 1998. "Asset Prices and Trading Volume in a Beauty Contest," Review of Economic Studies, Oxford University Press, vol. 65(2), pages 307-340.
    2. Stephen Morris, 1996. "Speculative Investor Behavior and Learning," The Quarterly Journal of Economics, Oxford University Press, vol. 111(4), pages 1111-1133.
    3. Abreu, Dilip & Brunnermeier, Markus K., 2002. "Synchronization risk and delayed arbitrage," Journal of Financial Economics, Elsevier, vol. 66(2-3), pages 341-360.
    4. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
    5. Brunnermeier, Markus K., 2001. "Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding," OUP Catalogue, Oxford University Press, number 9780198296980.
    6. Albert S. Kyle, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Oxford University Press, vol. 56(3), pages 317-355.
    7. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
    8. J. Michael Harrison & David M. Kreps, 1978. "Speculative Investor Behavior in a Stock Market with Heterogeneous Expectations," The Quarterly Journal of Economics, Oxford University Press, vol. 92(2), pages 323-336.
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    Cited by:

    1. Giovanni Cespa & Xavier Vives, 2012. "Dynamic Trading and Asset Prices: Keynes vs. Hayek," Review of Economic Studies, Oxford University Press, 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.

    More about this item

    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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