Irrational Market Makers

Fabrice Rousseau, Laurent Germain and Anne Vanhems ()
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Laurent Germain: University of Toulouse Toulouse Business SchoolISAE

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

Abstract: We analyze a model where irrational and rational informed traders exchange a risky asset with irrational market makers. Irrational traders misperceive the mean of prior information (optimistic/pessimistic bias) and the variance of the noise in their private signal (overconfidence/underconfidence bias). Irrational market makers misperceive both the mean and the variance of the prior information. We show 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: Irrational Traders; Irrational Market makers; Overconfidence; Optimism. (search for similar items in EconPapers)
JEL-codes: G00 G10 G14 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2013
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Journal Article: Irrational Market Makers (2014)
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