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Sentiment and speculation in a market with heterogeneous beliefs

Martin, Ian and Papadimitriou, Dimitris (2022) Sentiment and speculation in a market with heterogeneous beliefs. American Economic Review, 112 (8). 2465 - 2517. ISSN 0002-8282

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Identification Number: 10.1257/aer.20200505

Abstract

We present a model featuring risk-averse investors with heterogeneous beliefs. Individuals who are correct in hindsight—whether through luck or judgment—get rich, so sentiment is bullish following good news and bearish following bad news. Sentiment makes extreme outcomes far more important for pricing and has asymmetric effects on left- and right-skewed assets. Investors take speculative positions that can conflict with their fundamental views. Moderate investors are contrarian: they trade against excess volatility created by extremists. All investors view speculation as socially costly; but they also think it is in their self-interest, and the market can collapse entirely if speculation is banned.

Item Type: Article
Official URL: https://www.aeaweb.org/journals/aer
Additional Information: © 2022 American Economic Association
Divisions: Finance
Subjects: H Social Sciences > HB Economic Theory
JEL classification: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty
D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search; Learning; Information and Knowledge; Communication; Belief
G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
Date Deposited: 14 Mar 2022 09:51
Last Modified: 13 Sep 2022 23:20
URI: http://eprints.lse.ac.uk/id/eprint/114340

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