Rational trader risk

Kondor, Peter ORCID: 0000-0001-9797-9291 (2004) Rational trader risk. Financial Markets Group Discussion Papers (533). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

Allowing for a richer information structure than usual, we show that rational traders’ calculation with short-term price fluctuations may heavily influence their behaviour even if the interim price is not influenced by non-rational agents i.e. there is no noise trader risk. Instead, traders expect that new rational entrants with different information in the interim period will drive the price against them. Consequently, rational traders in the first period will hesitate to trade on their private information or - in the extreme - will trade against their private information i.e. buy more of the risky asset when they consider it worse. In the first part we develop a microstructure model with learning where the above effect will result in severe inefficiency and mispricing. In the second part, we discuss the critical properties of the information structure which are expected to result in similar findings in general models.

Item Type:	Monograph (Discussion Paper)
Official URL:	http://fmg.ac.uk
Additional Information:	© 2004 The Author
Divisions:	Financial Markets Group
Subjects:	H Social Sciences > HF Commerce H Social Sciences > HG Finance H Social Sciences > HB Economic Theory
JEL classification:	G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates D - Microeconomics > D4 - Market Structure and Pricing D - Microeconomics > D8 - Information, Knowledge, and Uncertainty G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
Date Deposited:	29 Jul 2009 11:17
Last Modified:	01 Oct 2024 04:03
URI:	http://eprints.lse.ac.uk/id/eprint/24646

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