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The Price Impact and Survival of Irrational TradersLeonid KoganMassachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER) Stephen A. RossMassachusetts Institute of Technology (MIT) - Sloan School of Management; Yale University - International Center for Finance Jiang WangMassachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER) Mark M. WesterfieldUniversity of Washington MIT Sloan Working Paper No. 4293-03 AFA 2004 San Diego Meetings 14th Conference on Financial Economics & Acctg. (FEA) 5th Ann. Texas Finance Festival Abstract: Milton Friedman argued that irrational traders will consistently lose money, won't survive and, therefore, cannot influence long run asset prices. Since his work, survival and price impact have been assumed to be the same. In this paper, we demonstrate that survival and price impact are two independent concepts. The price impact of irrational traders does not rely on their long-run survival and they can have a significant impact on asset prices even when their wealth becomes negligible. We also show that irrational traders' portfolio policies can deviate from their limits long after the price process approaches its long-run limit. In contrast to a partial equilibrium analysis, these general equilibrium considerations matter for the irrational traders' long-run survival.
Number of Pages in PDF File: 42 Keywords: Irrational Traders, Price Impact, Price Influence, Survival, Irrationality, Long Run Prices JEL Classification: G0, G1, D4 working papers seriesDate posted: January 20, 2004Suggested CitationContact Information
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