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Trading Frenzies and their Impact on Real Investment

  • Itay Goldstein

    ()

  • Emre Ozdenoren

    ()

  • Kathy Yuan

    ()

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 pressure on prices. 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 analyse the effect of various market parameters on the likelihood of trading frenzies to arise.

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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp670.

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Date of creation: Feb 2011
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Handle: RePEc:fmg:fmgdps:dp670
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