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Financial Crises in Efficient Markets: How Fundamentalists Fuel Volatility

  • Ariane Szafarz

When a financial crisis breaks out, speculators typically get the blame whereas fundamentalists are presented as the safeguard against excessive volatility. This paper proposes an asset pricing model where two types of rational traders coexist: short-term speculators and long-term fundamentalists, both sharing the same information set. In this framework, excess volatility not only exists, but is actually fueled by fundamental trading. Actually, efficient markets are more volatile with a few speculators than with many speculators. Regulators should therefore be aware that efforts to limit speculation might, surprisingly, end up increasing volatility.

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Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers CEB with number 10-052.

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Length: 25 p.
Date of creation: Nov 2010
Date of revision:
Publication status: Published by:
Handle: RePEc:sol:wpaper:2013/67769
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