The Short-Termism of Traders and Equilibrium Multiplicity

Abstract

We investigate the impacts of the short-termism on multiple equilibria in a dynamic rational expectations equilibrium model. We find that short-termism is not the cause of equilibrium multiplicity but affects market quality of all equilibria. The liquidity, price efficiency and expected trading volume in high trading intensity equilibrium (HTIE) are higher than those in low trading intensity equilibrium (LTIE) no matter how myopic the informed traders are. As investors’ myopia degree increases, this difference between HTIE and LTIE becomes larger. The LTIE is always stable but the speed of convergence to new equilibrium is negatively related to the myopia degree of traders when an unexpected shock moves the price away from equilibrium. The opposite happens in HTIE.

Keywords: short-termism; multiple equilibria; market liquidity; equilibrium stability

JEL Classification: D40, D82, G14