Dynamic Trading and Asset Prices: Keynes Vs. Hayek

Abstract

This is the accepted version of the paper.This version of the publication may differ from the final published version. We investigate the dynamics of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model with long-term investors. We argue that the fact that prices can score worse or better than consensus opinion in predicting the fundamentals is a product of endogenous short-term speculation. For a given, positive level of residual payoff uncertainty, if liquidity trades display low persistence rational investors act like market makers, accommodate the order flow, and prices are farther away from fundamentals compared to consensus. This defines a "Keynesian" region; the complementary region is "Hayekian" in that rational investors chase the trend and prices are systematically closer to fundamentals than average expectations. The standard case of no residual uncertainty and liquidity trading following a random walk is on the frontier of the two regions and identifies the set of deep parameters for which rational investors abide by Keynes' dictum of concentrating on an asset "long term prospects and those only." The analysis also explains momentum and reversal in stock returns and how accommodation and trend chasing strategies differ from these phenomena. Permanent repository link:

High Frequency Trading and Fragility

“…Fourth, by highlighting the first order asset pricing impact of uninformed traders' imbalance predictability, this paper shares some features of our previous work (Cespa and Vives (2012), and Cespa and Vives (2015)). In that setup, however, predictability obtained because of the assumed statistical properties of noise traders' demands, whereas in this paper it arises endogenously, because of a participation friction.…”

A battle of informed traders and the market game foundations for rational expectations equilibrium

“…Gottardi and Serrano (2005) show that the REE allocation is consistent with equilibrium for the market with clienteles (where a buyer is matched to one seller in a period), and that the REE allocation obtains in all equilibria for the market without clienteles (where a buyer can purchase from any seller). 6 Vives (2011a) considers a static game in which traders submit supply functions and demonstrates that the equilibrium converges to the fully revealing REE. The present paper adds to this literature in several ways.…”

“…, and is a von Neumann-Morgenstern expected utility maximizer with the twice continuously differentiable and quasilinear Bernoulli utility function in state  given by   (   ) +   . 8 We make the 6 The difference in the results in these two papers is related to the fact that Wolinsky (1990) considers steady state equilibria and Gottardi and Serrano (2005) consider a nonstationary economy with a finite number of agents. Gale (1987) considers an economy without uncertainty, and he shows that as search and bargaining frictions approach zero, the equilibrium allocation converges to the competitive equilibrium allocation.…”

Information Disclosure, Intertemporal Risk Sharing, and Asset Prices

“…The trading setting of the present paper is similar to Allen, Morris, and Shin (2006). Other papers on financial markets with myopic traders are Tirole (1982) and Cespa and Vives (2008). In Shin (2006), managers and investors have asymmetric information.…”