Sentiment and Speculation in a Market with Heterogeneous Beliefs
AbstractWe present a model featuring risk-averse investors with heterogeneous beliefs. Individuals who are correct in hindsight—whether through luck or judgment—get rich, so sentiment is bullish following good news and bearish following bad news. Sentiment makes extreme outcomes far more important for pricing and has asymmetric effects on left- and right-skewed assets. Investors take speculative positions that can conflict with their fundamental views. Moderate investors are contrarian: they trade against excess volatility created by extremists. All investors view speculation as socially costly; but they also think it is in their self-interest, and the market can collapse entirely if speculation is banned.
CitationMartin, Ian W. R., and Dimitris Papadimitriou. 2022. "Sentiment and Speculation in a Market with Heterogeneous Beliefs." American Economic Review, 112 (8): 2465-2517. DOI: 10.1257/aer.20200505
- D81 Criteria for Decision-Making under Risk and Uncertainty
- D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
- G11 Portfolio Choice; Investment Decisions
- G12 Equities; Fixed Income Securities
- G41 Behavioral Finance: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets [Neurofinance]