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Trading frenzies and their impact on real investment

2013; Elsevier BV; Volume: 109; Issue: 2 Linguagem: Inglês

10.1016/j.jfineco.2013.03.011

1879-2774

Itay Goldstein, Emre Ozdenoren, Kathy Yuan,

Economic theories and models

We study a model in which a capital provider learns from the price of a firm's security in deciding how much capital to provide for new investment. This feedback effect from the financial market to the investment decision gives rise to trading frenzies, in which speculators all wish to trade like others, generating large pressure on prices. Coordination among speculators is sometimes desirable for price informativeness and investment efficiency, but speculators' incentives push in the opposite direction, so that they coordinate exactly when it is undesirable. We analyze the effect of various market parameters on the likelihood of trading frenzies to arise.