Financial Markets Where Traders Neglect the Informational Content of Prices
74 Pages Posted: 15 Feb 2018
Date Written: February 4, 2018
We model a financial market where some traders of a risky asset do not fully appreciate what prices convey about others' private information. Markets comprising solely such "cursed" traders generate more trade than those comprising solely rationals. Because rationals arbitrage distortions caused by cursed traders, mixed markets can generate even more trade. Per-trader volume in cursed markets increases with market size; volume may instead disappear when traders infer others' information from prices, even when they dismiss it as noisier than their own. Making private information public raises rational and "dismissive" volume, but lowers cursed volume given moderate non-informational trading motives.
Keywords: behavioral finance, asymmetric information, trading volume, cursedness, overconfidence
JEL Classification: G02, G11, G12, D82
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