Is Rational Speculation in the Presence of Positive Feedback Traders Destabilizing?

Lutz Arnold () and Stephan Brunner

No 119, Working Papers from Bavarian Graduate Program in Economics (BGPE)

Abstract: DeLong (1990a) et al. show that in the presence of positive feedback traders rational speculation can be destabilizing, in that it drives the price of a risky asset above its expected value. A generalization of their seminal model with additional trading dates and an additional informative signal yields further interesting insights: it helps clarify when prices overreact, underreact, or even move in the "wrong" direction; when rational speculation is destabilizing or stabilizing; and whether overreaction is a symptom of market inefficiency or a manifestation of informational efficiency.

Keywords: market efficiency; positive feedback trading (search for similar items in EconPapers)
JEL-codes: G12 G14 (search for similar items in EconPapers)
Pages: 20 pages
Date: 2012-06
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