Non‐Fundamental Speculation

Abstract

We study an intertemporal asset market where insiders coexist with “non‐fundamental” speculators. Non‐fundamental speculators possess no private information on fundamental values of assets, but have superior knowledge about some aspect of the market environment. We show that the entry of these (rational) speculators can lead to reductions in market liquidity and in the information content of prices, even in an efficient market. Also, equilibrium trades display patterns of empirical interest. For example, speculators appear to chase trends and lose money after market “overreactions,” while insiders trade as contrarians and profit after such overreactions.

Informed Trading, Information Asymmetry, and Pricing of Information Risk: Empirical Evidence from the NYSE

“…Easley, et al (2002) could be one explanation. If informed traders exploit information on the stock-level trading environment (Madrigal (1996)), this co-variation could be across the entire market or could be associated with the market environment of individual stocks. Informed trades based on insider information, by contrast, should not show commonality.…”

Liquidity and Asset Prices

“…Whereas the above-mentioned papers deal with the effects of private information about fundamental news, there is also a more recent literature that recognizes the importance of private information about order flow; for example, a trader might be using his knowledge about someone else moving a large block of shares. This literature includes Madrigal (1996) who considers non-fundamental speculation, Attari et al (2005) and Brunnermeier and Pedersen (2005b) who study predatory trading (trading the exploits or induces other traders need to liquidate a position), 16 Vayanos (2001) and Cao et al (2003) who consider strategic trading due to risk sharing, and Gallmeyer et al (2004) who study uncertainty about the preferences of potential counterparties.…”

Speculative Bubbles - An Introduction and Application of the Speculation Elicitation Task (SET)

“…Moinas and Pouget (2013) nd that the QRE provides the 1 Early papers assuming rational expectations and full information suggest that investing in a growing bubble can be rational if a number of restrictions on the asset and trading environment are met (see, e.g., Blanchard and Watson, 1983). Subsequent heterogeneous agents models (HAM), which allow for trader heterogeneity in rationality and/or information, echo this conclusion (Froot et al, 1992;Madrigal, 1996;Hong and Stein, 1999). Here, a central idea is the "greater fool theory" where asset prices that deviate from their fundamental value can be justied rationally under the belief that another party (a`greater fool' or`noise trader') is willing to pay an even higher price (De Long et al, 1990).…”