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When overconfident traders meet feedback traders

Boco, Hervé and Germain, Laurent and Rousseau, Fabrice When overconfident traders meet feedback traders. (2011) In: Midwest Finance Association Annual Meeting, 3-6 Mar 2011, Chicago, United States .

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Abstract

In this paper, we develop a model in which overconfident market participants and rational speculators trade against trend-chasers. We exhibit the unique linear equilibrium and assess the quality of prices according to the proportion of the different types of agents. We highlight how speculative bubbles arise when a large number of traders adopt a trend-chasing behavior. We show that overconfident traders can obtain positive expected profits. In particular, over-confident traders can outperform rational traders. The positive feedback trading enhances the negative correlation between the back-to-back prices changes and the volatility of prices as well. We show that positive feedback traders destabilize prices more than their overconfident opponents. Generally, overconfidence increases the volatility of prices and worsens the market efficiency. But, we show that in the presence of positive feedback trading, overconfidence improves the market efficiency and dampens the excess volatility.

Item Type:Conference or Workshop Item (Paper)
Audience (journal):International peer-reviewed journal
Audience (conference):International conference proceedings
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Institution: Université de Toulouse > Institut Supérieur de l'Aéronautique et de l'Espace - ISAE
Université de Toulouse > Groupe École Supérieure de Commerce de Toulouse - ESCT
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Deposited By:odile huynh

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