The Price Impact and Survival of Irrational Traders

50 Pages Posted: 10 Jan 2003 Last revised: 20 Aug 2009

See all articles by Leonid Kogan

Leonid Kogan

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Stephen A. Ross

Massachusetts Institute of Technology (MIT) - Sloan School of Management; Yale University - International Center for Finance

Jiang Wang

Massachusetts Institute of Technology (MIT) - Sloan School of Management; China Academy of Financial Research (CAFR); National Bureau of Economic Research (NBER)

Mark M. Westerfield

University of Washington

Multiple version iconThere are 3 versions of this paper

Date Written: January 2003

Abstract

Milton Friedman argued that irrational traders will consistently lose money, won't survive and, therefore, cannot influence long run equilibrium asset prices. Since his work, survival and price influence have been assumed to be the same. Often partial equilibrium analysis has been relied upon to examine the survival of irrational traders and to make inferences on their influence on prices. In this paper, we demonstrate that survival and influence on prices are two independent concepts. The price impact of irrational traders does not rely on their long-run survival and they can have a significant impact on asset prices even when their wealth becomes negligible. In addition, in contrast to a partial equilibrium analysis, general equilibrium considerations matter since the ability of irrational traders to impact prices even when their wealth is diminishing can significantly affect their chances for long-run survival. In sum, in a long-run equilibrium, we explicitly show that price impact can occur whether or not the irrational traders survive. In related work, we show that even if the irrational traders survive they may have no price impact.

Suggested Citation

Kogan, Leonid and Ross, Stephen A. and Wang, Jiang and Westerfield, Mark M., The Price Impact and Survival of Irrational Traders (January 2003). NBER Working Paper No. w9434. Available at SSRN: https://ssrn.com/abstract=368190

Leonid Kogan (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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National Bureau of Economic Research (NBER)

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Stephen A. Ross

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Yale University - International Center for Finance

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Jiang Wang

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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China Academy of Financial Research (CAFR)

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National Bureau of Economic Research (NBER)

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Mark M. Westerfield

University of Washington ( email )

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