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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Financial Economics, Volume 81, Issue 2, August 2006, Pages 311–338
We provide a model in which irrational investors trade based upon considerations that have no inherent connection to fundamentals. However, trading activity affects market prices, and because of feedback from security prices to cash flows, the irrational trades influence underlying cash flows. As a result, irrational investors can, in some situations, earn abnormal (i.e., risk-adjusted) profits that can exceed the abnormal profits of rational informed investors. Although the trading of irrational investors cause prices to deviate from fundamental values, stock prices follow a random walk.
Investors often share common misconceptions and errors of analysis. For example, a substantial number of investors employ technical rules that are supported by neither conceptual considerations nor empirical evidence. Fads of investment in industry sectors, methods of security analysis, and simplistic theories of the stock market tend to proliferate through the mass media and word of mouth. (Shiller, 2000, discusses such phenomena.) Groups of investors who have fallen prey to common elementary errors, such as confusing the company Telecommunications Incorporated with the firm with ticker symbol TCI, have caused large price movements in one stock based upon news arrival in another unrelated stock (see Rashes, 2001). As another indication of the commonality of trading errors, investors and prices sometimes react to the republication of information that is already public (see Ho and Michaely, 1988 and Huberman and Regev, 2001). Anecdotally, during the late 1990s it became increasingly popular to value stocks based upon ad hoc heuristics. For example, many analysts (and presumably the investors who listened to them) began to value tech firms based upon revenue instead of earnings; and to value e-commerce firms based upon eyeballs instead of revenue. These valuation methods allegedly were inappropriate, a criticism that, at least with the benefit of hindsight, seems to carry some weight.1 With the rise of the Internet, there has been increased opportunity for investors to gain improved information about stocks. However, questionable stock market theories can also be spread more rapidly and widely. A growing literature explores the effects of irrational trading on market prices and the profitability of such trading (Hirshleifer, 2001, and Barberis and Thaler, 2003, review this literature.). While our paper contributes to this literature, our focus is different. In contrast to the existing literature, irrational trading in our model does not provide profit opportunities to uninformed rational investors, even if they are aware that traders with psychological biases are in the market. From the perspective of the rational, but uninformed, investors, the market is informationally efficient. Nevertheless, irrational trading affects prices and, thereby, affects firms’ fundamental values. Moreover, the irrational investors in our model can, under some conditions, earn positive expected profits that can even exceed the profits of rational informed traders. We are not the first to consider conditions under which irrational traders can earn higher expected profits than fully rational ones. However, in previous work, the irrational traders either earn high average profits by accepting greater exposure to systematic risk or achieve higher average risk-adjusted profits by more aggressively exploiting private information.2,3 In our setting prices are set by risk-neutral uninformed market makers, so that the expected profits of irrational investors in our model do not derive from exposure to priced risk. Moreover, the irrational investors in our model have no inherent private information relating to the cash flows that firms generate. However, the misperceptions of irrational investors affect these underlying cash flows because of feedback from stock prices to cash flows. As a result, in equilibrium, irrational trading is correlated with cash flows. Feedback, which plays a central role in our model, can arise in practice for a variety of reasons. For example, a higher stock price can help firms attract customers and employees, can reduce the firm's cost of capital, and may provide a cheap currency for making acquisitions.4 Higher stock prices also can encourage increased investment in complementary technologies.5 In our basic model, feedback arises because the stakeholders of the firm (such as suppliers, customers, and employees) choose to make greater firm-specific investments (e.g., the workers exert more effort) when the firm's prospects are better. It is rational for them to do so because the firm provides better opportunities to its stakeholders when it is doing well. We also consider an extended model in which feedback arises because stock prices affect the amount of capital raised in a security issue.6 Another central feature of our model is that irrational traders are all eventually infused with the same sentiment. Some, however, are either infused with the sentiment earlier or simply are able to act on the sentiment and submit their trades before others. This gives an advantage to the irrational traders who submit their orders early, relative to those who submit their orders later. Furthermore, as we show, this can allow the early irrational investors to outperform rational informed investors, who observe a private signal about future cash flows but detect the irrational sentiment only after the early irrationals trade.7 Within this setting, if irrational investors are bullish, prices tend to increase first when the early irrationals buy and then again when the late irrationals buy. Irrational investors earn positive expected profits when they trade early but earn negative expected profits when they trade late. In the absence of feedback, because of the adverse market impact of their trades, the average profit of the irrational investor is negative. However, with feedback from prices to cash flows, the price effect of the irrational trades is not completely reversed, because the sentiment induced buying has a positive effect on fundamentals. As we show, when this feedback effect is sufficiently strong, the expected gains from early irrational trading outweighs the expected loss from late irrational trading, so that the combined profits can on average be positive and can even exceed the profits of traders with fundamental information. Feedback allows early irrational investors to, in effect, exploit a kind of second order private information, not about fundamentals per se, but about the future order flow of investors with similar psychological biases and the feedback to fundamentals that results from these later trades. However, this argument does not require that the irrational investors be sophisticated enough to anticipate the feedback effect. Indeed, we assume that irrational traders naı¨vely ignore the causality from prices to cash flows. The sequential arrival of correlated irrational trades automatically positions the early irrational investors to profit. Because prices are set by rational risk-neutral market makers, prices are efficient in the sense that there are no profitable trading strategies based upon publicly observable information. Nevertheless, irrational trading causes prices to deviate from fundamental value, and distorts real decisions. Thus, the analysis illustrates that market efficiency in the conventional sense does not preclude real effects of investor irrationality. Our analysis is closely related to some earlier models of securities trading. Subrahmanyam and Titman (2001) and Khanna and Sonti (2004) analyze feedback from the stock market to cash flows in a setting with fully rational investors. Here we examine the consequences of imperfectly rational trading. The relevance of having investors receive information at different times was explored by Froot et al. (1992) and Hirshleifer et al. (1994), both of which considered settings with rational investors and no feedback.8 The remainder of the paper is structured as follows. Section 2 describes the economic setting. Section 3 derives asset demands, expected profits to different kinds of traders, and numerical comparisons of the profitability of different kinds of traders. Section 4 provides a simplified version of the model and analytic results about the profitability of different trader classes. Section 5 explores equity issuance as an alternative channel of feedback. Section 6 provides an additional discussion of our assumptions and results and Section 7 concludes. Except where otherwise noted, all proofs are in the Appendix.
نتیجه گیری انگلیسی
An efficient financial market is often defined as a market in which all publicly available information is fully reflected in the prices of securities. This concept is important, in part, because of the link between the information conveyed by market prices and the allocation of resources (See, e.g., Hayek, 1945, and recent models by Fishman and Hagerty, 1989; Khanna et al., 1994; Subrahmanyam and Titman, 1999). In addition to the allocation of capital, the efforts of workers and other stakeholders may be allocated more efficiently when the actions of rational informed agents make financial market prices more informative. Our model considers the flip side of the coin and examines how irrational trading can affect resource allocation by way of its influence on market prices. As we show, when there is feedback from prices to real decisions, irrational trading strategies can generate positive expected profits. This suggests that irrational strategies can persist and have long-term effects on both market prices and the allocation of resources. Although irrational trading affects market prices and distorts resource allocation, it does not necessarily make markets informationally inefficient in the conventional sense. Indeed, in our model stock prices follow a random walk, and investors who receive no private information (real or imagined) are unable to realize abnormal returns.15 As a result, standard tests of market efficiency do not provide a gauge of the extent to which irrational investors distort market prices. Even if risk-adjusted returns are unpredictable, irrational trading can induce substantial deviations of prices from fundamentals, and can cause substantial shifts in resource allocation. While we analyze feedback-related phenomena at the firm level, our analysis also applies to industries that become susceptible to waves of investor sentiment. Indeed, the turn-of-the-millennium tech boom was consistent with sentiment influencing stakeholders as well as investment within the Internet sector. High stock prices encouraged executives and programmers to leave secure high-level positions to join Internet startups (see footnote 6), and also allowed Internet companies to raise capital and increase investment rapidly.16 Furthermore, owing to positive externalities between the investments of different dot-com firms, favorable investor sentiment may have fed back into higher long-run firm profitability.17 During this period, individuals and firms were being educated about the benefits of shopping on the Internet. The high stock prices and resulting activities of startups such as Amazon, e-Bay, and Yahoo helped develop a population of regular Web users, which probably contributed to the profitability of these firms. At the aggregate macroeconomic level, the irrationality in our model can be viewed as Keynesian animal spirits in the stock market. Irrational optimism or pessimism can affect aggregate corporate profitability through the feedback effect, and business activity could respond in a confirming way to irrational swings in sentiment. Such effects can be magnified when there are positive investment externalities across firms, as in Shleifer (2000) and Cooper and John (1988). Our approach suggests that even when aggregate stock price movements are motivated by irrational beliefs, the investors who drive these price movements could be making profitable investments. This in turn suggests that animal spirits can have a continuing influence on stock prices, investment, and business cycles.