When Overconfident Traders Meet Feedback Traders

Hervé Boco, Laurent Germain and Fabrice Rousseau

Finance, 2021, vol. 42, issue 3, 7-55

Abstract: We develop a model in which both overconfident informed market participants and rational informed speculators trade against trend chasers. In this model, positive feedback traders act like computer-based traders and generate positive feedback loops. In line with empirical findings, we report a positive relationship between the volatility of prices and the size of the price reversal. The presence of positive feedback traders leads to a higher degree of trading activity by both types of informed trader. Overconfidence can lead to less price volatility and more efficient prices. Moreover, overconfident traders may be better off than their rational counterparts.

Keywords: overconfidence; positive feedback trading; excess volatility; market algorithmic trading (search for similar items in EconPapers)
Date: 2021
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