Dynamic Trading and Asset Prices: Keynes vs. Hayek

Xavier Vives and Giovanni Cespa

No 7506, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We investigate the dynamics of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model. We show that prices are farther away from (closer to) fundamentals compared with average expectations if and only if traders over- (under-) rely on public information with respect to optimal statistical weights. Both phenomena, in turn, occur whenever traders speculate on short-run price movements. For a given, positive level of residual payoff uncertainty, over-reliance on public information obtains if noise trade displays low persistence. This defines a "Keynesian" region; the complementary region is "Hayekian" in that prices are systematically closer to fundamentals than average expectations. The standard case of no residual uncertainty and noise trading following a random walk is on the frontier of the two regions and identifies the set of deep parameters for which traders abide by Keynes' dictum of concentrating on an asset "long term prospects and those only." The analysis explains accommodation and trend chasing strategies as well as momentum and reversal.

Keywords: Average expectations; Efficient market hypothesis; Higher order beliefs; Long and short-term trading; Momentum; Opaqueness; Over-reliance on public information; Reversal (search for similar items in EconPapers)
JEL-codes: G10 G12 G14 (search for similar items in EconPapers)
Date: 2009-10
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Related works:
Journal Article: Dynamic Trading and Asset Prices: Keynes vs. Hayek (2012)
Working Paper: Dynamic Trading and Asset Prices: Keynes vs. Hayek (2009)
Working Paper: Dynamic Trading and Asset Prices: Keynes vs. Hayek (2008)
Working Paper: Dynamic trading and asset prices: Keynes vs. Hayek (2007)
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