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Price Discovery in the Presence of Boundedly Rational Agents
[journal article]
Abstract In this paper we propose a sequential model of security trading which, compared to existing models, is extended along the notions of Simon (1955), Rubinstein (1998), and Odean (1999) by adding boundedly rational traders. Our results indicate that both momentum and mean-reversion in asset prices can ... view more
In this paper we propose a sequential model of security trading which, compared to existing models, is extended along the notions of Simon (1955), Rubinstein (1998), and Odean (1999) by adding boundedly rational traders. Our results indicate that both momentum and mean-reversion in asset prices can be attributed to the presence of agents who are subject to systematic errors in the process of forecasting the liquidation value of a risky security. The length of the momentum period is inversely related to both the amount of information-based trading in the market and the rate at which asset specific information is learned by boundedly rational agents. Furthermore, the model allows explicitly to establish a link between the component of the bid-ask spread that can be explained by bounded rationality and both momentum and reversal.... view less
Classification
National Economy
Economic Statistics, Econometrics, Business Informatics
Free Keywords
Interest Rate Modelling; LIBOR Market Models; Derivatives Pricing; American Options
Document language
English
Publication Year
2008
Page/Pages
p. 235-249
Journal
Quantitative Finance, 8 (2008) 3
DOI
https://doi.org/10.1080/14697680601158692
Status
Postprint; peer reviewed
Licence
PEER Licence Agreement (applicable only to documents from PEER project)