Irrational Financial Markets

Fabrice Rousseau (), Laurent Germain, Fabrice Rousseau () and Anne Vanhems ()
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Fabrice Rousseau: Economics,Finance and Accounting, National University of Ireland, Maynooth
Laurent Germain: Toulouse Business School, France
Fabrice Rousseau: Economics, National University of Ireland, Maynooth
Authors registered in the RePEc Author Service: Fabrice Rousseau

Economics Department Working Paper Series from Department of Economics, National University of Ireland - Maynooth

Abstract: We analyze a model where irrational and rational traders exchange a risky asset with competitive market makers. Irrational traders misperceive the mean of prior information (optimistic/pessimistic bias), the variance of prior information (better/lower than average effect)and the variance of the noise in their private signal (overconfidence/underconfidence bias). When market makers are rational we obtain results identical to Kyle and Wang (1997). However if market makers are irrational, we obtain that moderately underconfident traders can outperform rational ones and that irrational market makers can fare better than rational ones. Lastly we find that extreme level of confidence implies high trading volume.

Keywords: Irrationality (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-cbe, nep-cta, nep-mst and nep-upt
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Citations: View citations in EconPapers (1)

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