The Beauty Contest and Short-Term Trading

Giovanni Cespa and Xavier Vives

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: Short-termism need not breed informational price inefficiency even when generating Beauty Contests. We demonstrate this claim in a two-period market with persistent liquidity trading and risk-averse, privately informed, short-term investors and find that prices reect average expectations about fundamentals and liquidity trading. Informed investors engage in "retrospective" learning to reassess inferences (about fundamentals) made during the trading game's early stages. This behavior introduces strategic complementarities in the use of information and can yield two stable equilibria that can be ranked in terms of liquidity, volatility, and informational efficiency. We derive implications that explain market anomalies as well as empirical regularities.

Keywords: price speculation; multiple equilibria; average expectations; public information; momentum and reversal (search for similar items in EconPapers)
JEL-codes: G10 G12 G14 (search for similar items in EconPapers)
Date: 2014-11-26
New Economics Papers: this item is included in nep-cta, nep-mic and nep-mst
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Related works:
Journal Article: The Beauty Contest and Short-Term Trading (2015)
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Persistent link: https://EconPapers.repec.org/RePEc:sef:csefwp:383

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