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Man or Machine? Rational trading without information about fundamentals

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  • Rossi, S
  • Tinn, K

Abstract

Systematic trading contingent on observed prices by agents uninformed about fundamentals has long been considered at odds with efficient markets populated by rational agents. In this paper we show that price-contingent trading is the equilibrium strategy of rational agents in efficient markets in which there is uncertainty about whether a large trader is informed. In this environment, knowing his own type and past trades (or lack of them) will be enough for a large trader to retrieve some private information about the fundamental indirectly even if he does not observe fundamental information directly. Such trader pursues price-contingent trading which remains profitable in a (semi-strong) efficient market. Our results generalize to a large variety of distributional assumptions. We then provide conditions under which price-contingent trading is positive-feedback or contrarian. On average both positive-feedback and contrarian trading help prices converge faster to fundamentals, although they can occasionally trigger divergence.

Suggested Citation

  • Rossi, S & Tinn, K, 2012. "Man or Machine? Rational trading without information about fundamentals," Working Papers 12194, Imperial College, London, Imperial College Business School.
  • Handle: RePEc:imp:wpaper:12194
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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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