Higher order expectations, illiquidity, and short-term trading

Arbeitspapier

We propose a theory that jointly accounts for an asset illiquidity and for the asset price potential over-reliance on public information. We argue that, when trading frequencies differ across traders, asset prices reflect investors' Higher Order Expectations (HOEs) about the two factors that influence the aggregate demand: fundamentals information and liquidity trades. We show that it is precisely when asset prices are driven by investors' HOEs about fundamentals that they over-rely on public information, the market displays high illiquidity, and low volume of informational trading; conversely, when HOEs about fundamentals are subdued, prices under-rely on public information, the market hovers in a high liquidity state, and the volume of informational trading is high. Over-reliance on public information results from investors' under-reaction to their private signals which, in turn, dampens uncertainty reduction over liquidation prices, favoring an increase in price risk and illiquidity. Therefore, a highly illiquid market implies higher expected returns from contrarian strategies. Equivalently, illiquidity arises as a byproduct of the lack of participation of informed investors in their capacity of liquidity suppliers, a feature that appears to capture some aspects of the recent crisis.

Angaben zum Objekt

• Sprache: Englisch

Verweise und Beziehungen

• Erschienen in: Series: CESifo Working Paper ; No. 3390

Klassifikation und Themen

• Klassifikation: Wirtschaft ; General Financial Markets: General (includes Measurement and Data) ; Asset Pricing; Trading Volume; Bond Interest Rates ; Information and Market Efficiency; Event Studies; Insider Trading
• Thema: expected returns ; multiple equilibria ; average expectations ; over-reliance on public information ; Beauty Contest ; Kapitalertrag ; Erwartungstheorie ; Wertpapierhandel ; Informationsverhalten ; Marktliquidität ; Börsenkurs ; Theorie

Beteiligte, Orts- und Zeitangaben

• Ereignis: Geistige Schöpfung
• (wer): Cespa, Giovanni ; Vives, Xavier
• Ereignis: Veröffentlichung
• (wer): Center for Economic Studies and ifo Institute (CESifo)
• (wo): Munich
• (wann): 2011

Weitere Informationen

• Handle: http://hdl.handle.net/10419/46346
• Letzte Aktualisierung: 10.03.2025, 11:44 MEZ