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Dynamic Trading and Asset Prices: Keynes vs. Hayek

  • Giovanni Cespa

    ()

    (Queen Mary University of London, Università di Salerno, CSEF and CEPR)

  • Xavier Vives

    (IESE Business School and UPF)

We investigate the dynamics of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model. We look at the bias of prices as estimators of fundamental value in relation to traders' average expectations and note that prices are more (less) biased than average expectations if and only if traders over- (under-) rely on public information with respect to optimal statistical weights. We find that prices are biased in relation to average expectations whenever traders speculate on short-run price move- ments. In a market with long term traders, over-reliance on public information obtains if noise trade increments are correlated enough and/or there is low enough residual uncertainty in the payoff. This defines a “Keynesian” region; the complementary region is “Hayekian” in that prices are less biased than average expectations in the estimation of fundamental value. The standard case of no residual uncertainty and noise trading following a random walk is on the frontier of the two regions. With short-term traders there typically are two equilibria, with the stable (unstable) one displaying over- (under-) reliance on public information.

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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 191.

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Date of creation: 01 Jan 2008
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Publication status: Published in Review of Economic Studies (2012) 79 (2): 539-580.
Handle: RePEc:sef:csefwp:191
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  18. Wang, Jiang, 1959- & He, Hua., 1994. "Differential information and dynamic behavior of stock trading volume," Working papers 3731-94., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  20. Jayant Vivek Ganguli & Liyan Yang, 2009. "Complementarities, Multiplicity, and Supply Information," Journal of the European Economic Association, MIT Press, vol. 7(1), pages 90-115, 03.
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  24. Philippe BACCHETTA & Eric VAN WINCOOP, 2004. "Higher Order Expectations in Asset Pricing," FAME Research Paper Series rp110, International Center for Financial Asset Management and Engineering.
  25. Peter Kondor, 2004. "The more we know, the less we agree: public announcements and higher-order expectations," LSE Research Online Documents on Economics 24645, London School of Economics and Political Science, LSE Library.
  26. Cho, Jin-Wan & Krishnan, Murugappa, 2000. "Prices as Aggregators of Private Information: Evidence from S&P 500 Futures Data," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(01), pages 111-126, March.
  27. Vives, Xavier, 1997. "Learning from Others: A Welfare Analysis," Games and Economic Behavior, Elsevier, vol. 20(2), pages 177-200, August.
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