The Price Impact and Survival of Irrational Traders
Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)
Stephen A. Ross
Massachusetts Institute of Technology (MIT) - Sloan School of Management; Yale University - International Center for Finance
Massachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)
Mark M. Westerfield
University of Washington
Journal of Finance, February 2006
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.
Keywords: Irrational Traders, Price Impact, Price Influence, Survival, Irrationality, Long Run Prices
JEL Classification: G0, G1, D4Accepted Paper Series
Date posted: September 12, 2005
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