The Price Impact and Survival of Irrational Traders

42 Pages Posted: 20 Jan 2004

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

Abstract

Milton Friedman argued that irrational traders will consistently lose money, won't survive and, therefore, cannot influence long run asset prices. Since his work, survival and price impact have been assumed to be the same. In this paper, we demonstrate that survival and price impact 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. We also show that irrational traders' portfolio policies can deviate from their limits long after the price process approaches its long-run limit. In contrast to a partial equilibrium analysis, these general equilibrium considerations matter for the irrational traders' long-run survival.

Keywords: Irrational Traders, Price Impact, Price Influence, Survival, Irrationality, Long Run Prices

JEL Classification: G0, G1, D4

Suggested Citation

Kogan, Leonid and Ross, Stephen A. and Wang, Jiang and Westerfield, Mark M., The Price Impact and Survival of Irrational Traders. MIT Sloan Working Paper No. 4293-03; AFA 2004 San Diego Meetings; 14th Conference on Financial Economics & Acctg. (FEA); 5th Ann. Texas Finance Festival. Available at SSRN: https://ssrn.com/abstract=387540 or http://dx.doi.org/10.2139/ssrn.387540

Leonid Kogan (Contact Author)

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

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HOME PAGE: http://web.mit.edu/lkogan2/www/

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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Cambridge, MA 02142
United States
617-253-2632 (Phone)
617-258-6855 (Fax)

China Academy of Financial Research (CAFR)

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Shanghai P.R.China, 200030
China

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Mark M. Westerfield

University of Washington ( email )

Box 353200
Seattle, WA 98195
United States

HOME PAGE: http://www.markwesterfield.com

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