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Supply and Shorting in Speculative Markets

Listed author(s):
  • Marcel Nutz
  • José A. Scheinkman

We propose a continuous-time model of trading among risk-neutral agents with heterogeneous beliefs. Agents face quadratic costs-of-carry on their positions and as a consequence, their marginal valuation of the asset decreases when the magnitude of their position increases, as it would be the case for risk-averse agents. In the equilibrium models of investors with heterogeneous beliefs that followed the original work by Harrison and Kreps, investors are risk-neutral, short-selling is prohibited and agents face a constant marginal cost of carrying positions. The resulting resale option guarantees that the equilibrium price exceeds the price of the asset in a static buy-and-hold model where speculation is ruled out. Our model features three main novelties. First, increasing marginal costs entail that the price depends on the exogenous supply. Second, in addition to the resale option, agents may also value an option to delay, and this may cause the market to equilibrate below the static buy-and-hold price. Third, we introduce the possibility of short-selling; then the resale option for agents with short positions partly compensates the resale option for long agents. We characterize the unique equilibrium of our model through a Hamilton--Jacobi--Bellman equation of a novel form and use it to derive several comparative statics results.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 23751.

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Date of creation: Aug 2017
Handle: RePEc:nbr:nberwo:23751
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  1. Johannes Muhle-Karbe & Marcel Nutz, 2016. "A Risk-Neutral Equilibrium Leading to Uncertain Volatility Pricing," Papers 1612.09152, arXiv.org.
  2. Manuel S. Santos & Michael Woodford, 1997. "Rational Asset Pricing Bubbles," Econometrica, Econometric Society, vol. 65(1), pages 19-58, January.
  3. Harris, Ron, 1994. "The Bubble Act: Its Passage and Its Effects on Business Organization," The Journal of Economic History, Cambridge University Press, vol. 54(03), pages 610-627, September.
  4. Harrison Hong & José Scheinkman & Wei Xiong, 2006. "Asset Float and Speculative Bubbles," Journal of Finance, American Finance Association, vol. 61(3), pages 1073-1117, 06.
  5. Wei Xiong & Jialin Yu, 2011. "The Chinese Warrants Bubble," American Economic Review, American Economic Association, vol. 101(6), pages 2723-2753, October.
  6. Bernard Dumas & Alexander Kurshev & Raman Uppal, 2009. "Equilibrium Portfolio Strategies in the Presence of Sentiment Risk and Excess Volatility," Journal of Finance, American Finance Association, vol. 64(2), pages 579-629, 04.
  7. Wei Xiong & Jialin Yu, 2011. "The Chinese Warrants Bubble," Working Papers 1398, Princeton University, Department of Economics, Econometric Research Program..
  8. Harrison Hong & Jeremy C. Stein, 2007. "Disagreement and the Stock Market," Journal of Economic Perspectives, American Economic Association, vol. 21(2), pages 109-128, Spring.
  9. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
  10. John H. Cochrane, 2002. "Stocks as Money: Convenience Yield and the Tech-Stock Bubble," NBER Working Papers 8987, National Bureau of Economic Research, Inc.
  11. Eli Ofek & Matthew Richardson, 2003. "DotCom Mania: The Rise and Fall of Internet Stock Prices," Journal of Finance, American Finance Association, vol. 58(3), pages 1113-1138, 06.
  12. 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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