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Nonfundamental Speculation Revisited

Liyan Yang and Haoxiang Zhu

Journal of Finance, 2017, vol. 72, issue 6, 2759-2772

Abstract: We show that a linear pure strategy equilibrium may not exist in the model of Madrigal (1996), contrary to the claim of the original paper. This is because Madrigal's characterization of a pure strategy equilibrium omits a second†order condition. If the nonfundamental speculator's information about noise trading is sufficiently precise, a linear pure strategy equilibrium fails to exist. In parameter regions where a pure strategy equilibrium does exist, we identify a few calculation errors in Madrigal (1996) that result in misleading implications.

Date: 2017
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