Asset Price Dynamics When Traders Care About Reputation
London School of Economics (LSE); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)
London School of Economics (LSE) - Department of Economics; Centre for Economic Policy Research (CEPR)
CEPR Discussion Paper No. 5372
What are the equilibrium features of a dynamic financial market where traders care about their reputation for ability? We modify a standard sequential trading model to study a financial market with career concerns. We show that this market cannot be informationally efficient: there is no equilibrium in which prices converge to the true value, even after an infinite sequence of trades. This finding, which stands in sharp contrast with the results for standard financial markets, is due to the fact that our traders face an endogenous incentive to behave in a conformist manner. We show that there exist equilibria where career-concerned agents trade in a conformist manner when prices have risen or fallen sharply. We also show that each asset carries an endogenous reputational benefit or cost, which may lead to systematic mispricing if asset supply is not infinitely elastic.
Number of Pages in PDF File: 43
Keywords: Financial equilibrium, career concerns, information cascades, mispricing
JEL Classification: C7, G0working papers series
Date posted: February 20, 2006
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