FRIC/Finance Seminar with Dimitri Vayanos, London School of Economics

FRIC Center for Financial Frictions and the Department of Finance are proud to announce the upcoming seminar with Dimitri Vayanos, London School of Economics.

Dimitri Vayanos will present: 

Financial Markets where Traders Neglect the Informational Content of Prices

Authors:
Erik Eyster, London School of Economics
Matthew Rabin, Harvard University
Dimitri Vayanos, London School of Economics

ABSTRACT
We present a model of a financial market where some traders are “cursed” when choosing how much to invest in a risky asset, failing to fully take into account what prices convey about others’ private information. Cursedness induces traders to weight their private signals more heavily than rational traders. But because they neglect that the price encodes other traders’ information, prices depend less on private signals and more on public signals than rational-expectation-equilibrium (REE) prices. Markets comprised entirely of cursed traders generate more trade than those comprised entirely of rationals; mixed markets can generate even more trade, as rationals employ momentum-trading strategies to exploit cursed traders. We contrast our results to other models of departures from REE and show that per-trader volume with cursed traders increases when the market becomes large, while natural forms of overconfidence predict that volume should converge to zero.