Expectations, Illiquidity, and Short-Term Trading

61 Pages Posted: 29 Mar 2011  

Giovanni Cespa

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

Xavier Vives

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

Multiple version iconThere are 3 versions of this paper

Date Written: April 2014

Abstract

We consider a two-period market with persistent liquidity trading and risk averse privately informed investors who have a one period horizon. With persistence, prices reflect average expectations about fundamentals and liquidity trading. Informed investors engage in “retrospective” learning to reassess the inference about fundamentals made at the early stage of the trading game. This introduces strategic complementarities in the use of information and can yield two stable equilibria which can be ranked in terms of liquidity, volatility, and informational efficiency. We establish the limits of the beauty contest analogy for financial markets and derive a rich set of implications to explain market anomalies, and empirical regularities.

Keywords: price speculation, multiple equilibria, average expectations, public information, momentum and reversal, Beauty Contest

JEL Classification: G100, G120, G140

Suggested Citation

Cespa, Giovanni and Vives, Xavier, Expectations, Illiquidity, and Short-Term Trading (April 2014). CESifo Working Paper Series No. 3390. Available at SSRN: https://ssrn.com/abstract=1793768

Giovanni Cespa

Cass Business School ( email )

106, Bunhill Row
London, EC1Y 8TZ
Great Britain
+44(0)2040708704 (Phone)

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
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

Universitat Pompeu Fabra (UPF) ( email )

Ramon Trias Fargas, 25-27
Barcelona, 08005
Spain

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
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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