Feedback and the Success of Irrational Investors
Journal of Financial Economics, Vol. 81, No. 2, pp. 311-338, August 2006
Dice Center Working Paper No. 2003-22
40 Pages Posted: 28 Jul 2003 Last revised: 13 Dec 2008
Date Written: September 10, 2003
We provide a model in which irrational investors trade based upon considerations that are not inherently related to fundamentals. However, because trading activity affects market prices, and because of feedback from security prices to cash flows, the irrational trades influence underlying cash flows. As a result, irrational investors can, in some situations, earn positive expected profits. These expected profits are not market compensation for bearing risk, and can exceed the expected profits of rational informed investors. The trades of irrational investors can distort real investment choices and lower ex ante firm values, even though stocks prices follow a random walk.
JEL Classification: G14, D82, D84, E3
Suggested Citation: Suggested Citation