Speculation and Price Indeterminancy in Financial Markets

59 Pages Posted: 6 Nov 2015

See all articles by Shinichi Hirota

Shinichi Hirota

Waseda University - Graduate School of Commerce

Juergen Huber

University of Innsbruck; University of Vienna - Department of Finance

Thomas Stockl

Management Center Innsbruck (MCI)

Shyam Sunder

Yale University - School of Management; Yale University - Cowles Foundation

Date Written: November 4, 2015

Abstract

We explore how speculative trading causes price indeterminacy in financial markets. Contrary to standard finance theory, we argue that speculating investors’ difficulty in forming rational expectations induces security prices to deviate from the fundamental values. We conducted a laboratory asset market experiment with overlapping generations of investors. We find that in markets with speculating investors (i) price deviations are larger; (ii) price deviations increase as the holding period of investors shrinks (and frequency of security transfers increases); (iii) speculative trading creates upward (downward) pressure on prices when liquidity is high (low); and (iv) price expectations are formed through forward induction from recent price changes, instead of backward induction from the fundamentals. The results suggest that speculation causes price indeterminacy when dynamic formation of inter-temporal rational expectations is infeasible.

Keywords: Experimental economics, speculating investors, rational expectations, price efficiency, overlapping generations, backward and forward induction

JEL Classification: C91, G11, G12

Suggested Citation

Hirota, Shinichi and Huber, Juergen and Stockl, Thomas and Sunder, Shyam, Speculation and Price Indeterminancy in Financial Markets (November 4, 2015). Available at SSRN: https://ssrn.com/abstract=2686230 or http://dx.doi.org/10.2139/ssrn.2686230

Shinichi Hirota

Waseda University - Graduate School of Commerce ( email )

1-6-1, Nishi-Waseda
Shinjuku-ku, Tokyo 169-8050
Japan
+81-3-5286-2088 (Phone)
+81-3203-7067 (Fax)

Juergen Huber

University of Innsbruck ( email )

Universitätsstraße 15
Innsbruck, Innsbruck 6020
Austria

University of Vienna - Department of Finance ( email )

Bruenner Strasse 72
Vienna, 1210
Austria

Thomas Stockl

Management Center Innsbruck (MCI) ( email )

Universitaetsstr. 15
Innsbruck, 6020
Austria

Shyam Sunder (Contact Author)

Yale University - School of Management ( email )

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-6160 (Phone)

HOME PAGE: http://www.som.yale.edu/faculty/sunder/

Yale University - Cowles Foundation

Box 208281
New Haven, CT 06520-8281
United States

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