Trading Frenzy and Its Impact on Real Investment

33 Pages Posted: 17 Mar 2009 Last revised: 7 Dec 2011

See all articles by Itay Goldstein

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department

Emre Ozdenoren

London Business School; Centre for Economic Policy Research (CEPR)

Kathy Yuan

London School of Economics & Political Science (LSE) - Department of Finance

Date Written: May 22, 2009

Abstract

We study a model where a capital provider learns from the price of a firm's stock when making a decision how much capital to provide for new investment. The efficiency of the investment decision and the volatility of prices and investments depend crucially on the strategic interaction among speculators in the market. We show that speculators almost always coordinate either too much or too little, reducing the effectiveness of the financial market in guiding the investment decision. Our model gives rise to phenomena similar to what has happened in the recent crisis where speculators coordinate to 'run' on a stock, pushing down its price in a way that deprives the firm of capital and exacerbates the underlying problem.

Keywords: Coordination, Asset price, Feedback, Excess Volatility

JEL Classification: G12, E4, C7

Suggested Citation

Goldstein, Itay and Ozdenoren, Emre and Yuan, Kathy Zhichao, Trading Frenzy and Its Impact on Real Investment (May 22, 2009). AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1360907 or http://dx.doi.org/10.2139/ssrn.1360907

Itay Goldstein

University of Pennsylvania - The Wharton School - Finance Department ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States
215-746-0499 (Phone)

Emre Ozdenoren

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Kathy Zhichao Yuan (Contact Author)

London School of Economics & Political Science (LSE) - Department of Finance ( email )

Old Building
Houghton Street
London, London WC2A 2AE
United Kingdom
+44 (0)20 7955 6407 (Phone)
+44 (0)20 7849 4647 (Fax)

HOME PAGE: http://fmg.lse.ac.uk/~kathy

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