Dynamic Trading and Asset Prices: Keynes vs. Hayek

51 Pages Posted: 6 Nov 2009

See all articles by Giovanni Cespa

Giovanni Cespa

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

Xavier Vives

University of Navarra - IESE Business School; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

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Date Written: April 1, 2011

Abstract

We investigate the dynamics of prices, information and expectations in a competitive, noisy, dynamic asset pricing equilibrium model with long-term investors. We argue that the fact that prices can score worse or better than consensus opinion in predicting the fundamentals is a product of endogenous short-term speculation. For a given, positive level of residual payoff uncertainty, if noise trade displays low persistence rational investors act like market makers, accommodate the order flow, and prices are farther away from fundamentals compared to consensus. This defines a “Keynesian” region; the complementary region is “Hayekian” in that rational investors chase the trend and prices are systematically closer to fundamentals than average expectations. The standard case of no residual uncertainty and noise trading following a random walk is on the frontier of the two regions and identifies the set of deep parameters for which rational investors abide by Keynes’ dictum of concentrating on an asset “long term prospects and those only.” The analysis explains how accommodation and trend chasing strategies differ from momentum and reversal phenomena because of the different information sets that investors and an outside observer have.

Keywords: efficient market hypothesis, long and short-term trading, average expectations, higher order beliefs, over-reliance on public information, opaqueness, momentum, reversal

JEL Classification: G10, G12, G14

Suggested Citation

Cespa, Giovanni and Cespa, Giovanni and Vives, Xavier, Dynamic Trading and Asset Prices: Keynes vs. Hayek (April 1, 2011). CESifo Working Paper Series No. 2839, Available at SSRN: https://ssrn.com/abstract=1500276 or http://dx.doi.org/10.2139/ssrn.1500276

Giovanni Cespa

Bayes Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom
+44(0)2040708704 (Phone)

Bayes Business School ( email )

United Kingdom

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Xavier Vives (Contact Author)

University of Navarra - IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

HOME PAGE: http://wwwapp.iese.edu/faculty/facultyDetail.asp?lang=en&prof=xv

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

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