Speculative Trade with Anchored Expectations

Abstract

To model trading anomalies around major stock market milestones, I introduce a behavioral limitation in how traders form expectations. Resulting asset demands are shown to be periodic, where intervals represent market regimes in the eyes of the trader. Prices determined by heterogeneous traders subject to these behavioral constraints are shown to follow an endogenous Brownian motion. An equilibrium is established in the following sense: because traders are different, their aggregated trades induce a Brownian motion price process, yet the price process impedes traders from learning their differences. I then extend the result to heavy tailed return distributions, and highlight policies to curb non-fundamental volatility.

Keywords: Market Microstructure, Behavioral Finance, Anchoring, Price Barriers

JEL Classification: G14, G41, D84, D91