Copy Trading and Price Efficiency

Abstract

This paper investigates the effects of copy trading—a mechanism that allows investors to replicate the strategies of successful traders—on price efficiency. We consider a rational expectation equilibrium (REE) model in which investors either trade directly as passive traders or search for leaders as active followers. Active followers decide their replication position on strategies of informed leaders, rather than forming their own demand. However, these replication attempts are subject to factor-structured copy errors. While copy trading introduces informed capital by mirroring the strategies of informed leaders, it also injects systematic noise due to common replication errors among followers. When both active followers and passive traders are overconfident about the accuracy of these copy errors, our findings reveal a hump-shaped relationship between participation in copy trading and price efficiency under moderate levels of copy error.

Keywords: Price efficiency, copy trading, copy error

JEL Classification: G12