Does Speculation in Financial Markets Have Real Effects?

52 Pages Posted: 19 Jun 2019 Last revised: 25 Mar 2020

See all articles by Tao Li

Tao Li

City University of Hong Kong (CityUHK) - Department of Economics & Finance

Mark Loewenstein

University of Maryland - Robert H. Smith School of Business

Date Written: June 12, 2019

Abstract

This paper examines how speculation in financial markets can affect real investments and asset prices with asymmetric adjustment costs. Investors with recursive preferences have heterogeneous beliefs about real productivity and some extraneous risk and trade them in financial markets. Speculation in financial markets, even on extraneous risk uncorrelated with productivity, can significantly affect real investments and asset prices. Speculation can either decrease or increase real investment and asset prices depending on whether investors EIS is less or greater than 1. With the EIS above 1, speculation can generate various boom-and-bust patterns such as what happened in the recent US housing markets.

Keywords: Heterogeneous Belief, Production, Extraneous Risk, Housing Booms and Busts, Speculation, Recursive Preferences

JEL Classification: E32, G12, G18

Suggested Citation

Li, Tao and Loewenstein, Mark, Does Speculation in Financial Markets Have Real Effects? (June 12, 2019). Available at SSRN: https://ssrn.com/abstract=3401409 or http://dx.doi.org/10.2139/ssrn.3401409

Tao Li (Contact Author)

City University of Hong Kong (CityUHK) - Department of Economics & Finance ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Mark Loewenstein

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States

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