Risk Seekers: Trade, Noise, and the Rationalizing Effect of Market Impact on Convex Preferences

78 Pages Posted: 9 May 2018 Last revised: 31 Dec 2019

See all articles by Efstathios Avdis

Efstathios Avdis

University of Alberta - Department of Finance and Statistical Analysis

Date Written: December 30, 2019

Abstract

Long-held intuition dictates that information-based trade is impossible without exogenous noise. Risk seekers can resolve this conundrum. Even though such agents have negative risk aversion, they act as utility maximizers because they fully internalize their impact on prices. If their love of risk increases, information decreases in the aggregate, making prices noisier and returns more volatile. If public information becomes more precise, risk sharing decreases but welfare increases, contradicting the Hirshleifer effect. If private information becomes cheaper, liquidity always increases, rendering economies with risk seekers empirically distinct from economies with noise traders or random endowments.

Keywords: Rationality, inefficient markets, information acquisition, liquidity

JEL Classification: D01, D53, D82, E19, G12, G14

Suggested Citation

Avdis, Efstathios, Risk Seekers: Trade, Noise, and the Rationalizing Effect of Market Impact on Convex Preferences (December 30, 2019). University of Alberta School of Business Research Paper No. 2018-504, Available at SSRN: https://ssrn.com/abstract=3167569 or http://dx.doi.org/10.2139/ssrn.3167569

Efstathios Avdis (Contact Author)

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

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