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Survival in Speculative Markets

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  • Pietro Dindo

Abstract

In a dynamic stochastic exchange economy where, due to beliefs heterogeneity, agents engage in speculative trade, I investigate the Market Selection Hypothesis that speculation rewards the agent with the most accurate beliefs. Assuming that agents maximize Epstein-Zin preferences and that markets are complete, I derive sufficient conditions for agents' survival in terms of their saving and portfolio rules, and use them to show that the Market Selection Hypothesis fails generically. Beliefs heterogeneity and speculation may persist in the long-run or, even when discount factors and intertemporal elasticities of substitution are homogeneous, speculation may cause the agent with the most accurate beliefs to vanish. Failures occur because agents' portfolio returns depend not only on beliefs accuracy but also on risk preferences, through the comparison to the optimal growth portfolio. The latter plays no role in CRRA economies because, due to the interdependence of relative risk aversion and intertemporal elasticity of substitution, portfolio returns not related to beliefs accuracy are compensated by the precautionary component of saving.

Suggested Citation

  • Pietro Dindo, 2015. "Survival in Speculative Markets," LEM Papers Series 2015/32, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
  • Handle: RePEc:ssa:lemwps:2015/32
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    Cited by:

    1. Massari, Filippo, 2019. "Market selection in large economies: a matter of luck," Theoretical Economics, Econometric Society, vol. 14(2), May.
    2. Saki Bigio & Eduardo Zilberman, 2020. "Speculation-Driven Business Cycles," Working Papers Central Bank of Chile 865, Central Bank of Chile.
    3. Pietro Dindo & Filippo Massari, 2017. "The Wisdom of the Crowd in Dynamic Economies," Working Papers 2017:17, Department of Economics, University of Venice "Ca' Foscari", revised 2018.
    4. Norman, Thomas W.L., 2020. "Market selection with an endogenous state," Journal of Mathematical Economics, Elsevier, vol. 91(C), pages 51-59.
    5. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2018. "Long-run heterogeneity in an exchange economy with fixed-mix traders," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 66(2), pages 407-447, August.
    6. Daniele Giachini, 2018. "Rationality and Asset Prices under Belief Heterogeneity," LEM Papers Series 2018/07, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    7. Daniele Giachini, 2021. "Rationality and asset prices under belief heterogeneity," Journal of Evolutionary Economics, Springer, vol. 31(1), pages 207-233, January.
    8. Giulio Bottazzi & Daniele Giachini, 2020. "Selection in incomplete markets and the CAPM portfolio rule," LEM Papers Series 2020/29, Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy.
    9. Giulio Bottazzi & Pietro Dindo & Daniele Giachini, 2019. "Momentum and reversal in financial markets with persistent heterogeneity," Annals of Finance, Springer, vol. 15(4), pages 455-487, December.
    10. Massari, Filippo, 2017. "Markets with heterogeneous beliefs: A necessary and sufficient condition for a trader to vanish," Journal of Economic Dynamics and Control, Elsevier, vol. 78(C), pages 190-205.

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    More about this item

    Keywords

    Heterogeneous Beliefs; Speculation; Market Selection Hypothesis; Asset Pricing; Optimal Growth Portoflio; Epstein-Zin Preferences; Precautionary Saving;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • 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
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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