Tuesday, June 07, 2011

When Overconfident Traders Meet Feedback Traders by Laurent Germain, Fabrice Rousseau, Herve Boco :: SSRN

When Overconfident Traders Meet Feedback Traders by Laurent Germain, Fabrice Rousseau, Herve Boco :: SSRN:

An interesting follow up to the idea that herding is not good for markets.
"...model in which overconfident market participants and rational speculators trade against trend-chasers. We show that the growth and the burst of a financial bubble stem from positive feedback trading. However, the presence of overconfident traders and the risk aversion of the informed speculators enhance the strength of bubbles (creation and burst). The positive feedback trading enhances the negative serial correlation of prices and the volatility of prices. We show that positive feedback traders destabilize prices more than their overconfident opponents. Generally, overconfidence increases the volatility of prices and worsens the market efficiency."

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