Feedback Effects, Asymmetric Trading, and the Limits to Arbitrage

Alex Edmans, Itay Goldstein and Wei Jiang

American Economic Review, 2015, vol. 105, issue 12, 3766-97

Abstract: We analyze strategic speculators' incentives to trade on information in a model where firm value is endogenous to trading, due to feedback from the financial market to corporate decisions. Trading reveals private information to managers and improves their real decisions, enhancing fundamental value. This feedback effect has an asymmetric effect on trading behavior: it increases (reduces) the profitability of buying (selling) on good (bad) news. This gives rise to an endogenous limit to arbitrage, whereby investors may refrain from trading on negative information. Thus, bad news is incorporated more slowly into prices than good news, potentially leading to overinvestment. (JEL D83, G12, G14)

JEL-codes: D83 G12 G14 (search for similar items in EconPapers)
Date: 2015
Note: DOI: 10.1257/aer.20141271
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Citations: View citations in EconPapers (71)

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