Publisher:
Friedrich-Alexander-Universität Erlangen-Nürnberg, Bavarian Graduate Program in Economics (BGPE), Nürnberg
Abstract:
DeLong (1990a) et al. show that in the presence of positive feedback traders rational speculation can be destabilizing, in that it drives the price of a risky asset above its expected value. A generalization of their seminal model with additional trading dates and an additional informative signal yields further interesting insights: it helps clarify when prices overreact, underreact, or even move in the wrong direction; when rational speculation is destabilizing or stabilizing; and whether overreaction is a symptom of market inefficiency or a manifestation of informational efficiency.