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Self-Generating Trade And Rational Fads: The Response Of Price To New Information
01 Jan 1989-Research Papers in Economics (Wharton School - Weiss Center for International Financial Research)-
TL;DR: In this paper, the authors studied the dynamic behavior of security prices in a setting where two agents trade strategically and learn from market prices, and they showed that trade is self-generating.
Abstract: The dynamic behavior of security prices is studied in a setting where two agents trade strategically and learn from market prices. Each trader receives a private signal about fundamentals, the significance of which depends on the signal received by the other trader. In trading, each agent wants to deceive the other trader into revealing his signal, while not revealing his own signal. We show that trade is self-generating because agents learn the value of the asset only through observation of the market price. Uninformed agents, technical analysts, can also trade by charting past prices. These chartists ensure market efficiency. Equilibrium price paths of the model may display reversals in which all traders rationally revise their beliefs, first in one direction and then in the opposite direction even though no new information had entered the system. A piece of information which is initially thought to be bad news may be revealed, through trading, to be good news. This fad-like behavior results from rational strategic interaction and Bayesian inference. In this model security prices do not follow a martingale.(This abstract was borrowed from another version of this item.)
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TL;DR: This article found that trading halts increase both volume and volatility in the first full trading day after a trading halt, while non-halt control periods matched on time of day, duration, and absolute net-of-market returns.
Abstract: Trading halts increase, rather than reduce, both volume and volatility. Volume (volatility) in the first full trading day after a trading halt is 230 percent (50 to 115 percent) higher than following "pseudohalts": nonhalt control periods matched on time of day, duration, and absolute net-of-market returns. These results are robust over different halt types and news categories. Higher posthalt volume is observed into the third day while higher posthalt volatility decays within hours. The extent of media coverage is a partial determinant of volume and volatility following both halts and pseudohalts, but a separate halt effect remains after controlling for the media effect. IN THE WAKE OF the 1987 market break, a number of commentators, including the Presidential Task Force on Market Mechanisms, recommended the establishment of "circuit breaker" mechanisms. The primary argument supporting circuit breakers (both price limits and trading halts) is that nontrading periods provide an opportunity for normal information transmission in times of market duress. Proponents of circuit breakers claim that, during major price changes there can be a breakdown in the transmission of information between the trading floor and market participants. Therefore, "the primary function of a circuit breaker should be to reinform participants" (Greenwald and Stein (1988), p. 17). By lowering informational asymmetries between traders, halts could permit the orderly emergence of a new consensus price. But would "informative" trading halts succeed? Many academics are openly suspicious of any kind of market interference and assume that trading halts are guilty until proven innocent. Grossman (1990, p. 3), for example, argues that the closing of markets "merely prevents consenting adults from carrying out their desires on the floor of the stock exchange." Not only do halts impose a liquidity cost on traders, but studies suggest that information will not be as
291 citations
TL;DR: In this article, the authors assess the efficiency of trading halts by examining the return, volatility and volume behavior around news-initiated trading-halts through the unique microstructure and trade-by-trade data of the Istanbul Stock Exchange (ISE).
Abstract: Firm-specific trading halts have become a common practice in many international stock markets during the last two decades. However, the effects and effectiveness of trading halts remain controversial among academics and regulators. In this debate, it seems crucial to understand how the trading behavior of institutional and individual investors, the market microstructure and the duration of the halts are related to the effects of the trading halts. By considering these factors, this paper assesses the efficiency of trading halts by examining the return, volatility and volume behavior around news-initiated trading halts through the unique microstructure and trade-by-trade data of the Istanbul Stock Exchange (ISE). It also investigates, for the first time, the trading behavior of different types of investors such as individuals, mutual funds and brokerage houses around trading halts. Findings show that most of the new information is absorbed by prices within fifteen minutes (almost completely in an hour) following the resume of trading after a halt. Reaction of investors to bad news is slower and stronger than good news. Our results are robust to time-of-halt and duration-of-halt effects. Price discovery mechanisms based on fully computerized trading, non-existence of monopolist specialists and opening batch mechanisms, and restrictions on order cancellation during trading are some of the factors that accelerate the speed of adjustment in prices. In spite of halts, institutional investors would take the price advantage of new information during the halt period ahead of the individual investors by doing better timing in trading after halts. Institutional investors systematically buy and sell at more favorable prices around halts than individual investors do. Finally, overall evidence suggests that trading halts are effective in dissemination of valuable information and play an important role in enhancing the efficiency of the price discovery mechanism.
8 citations
Cites background from "Self-Generating Trade And Rational ..."
...5 McNichols (1989), Dow and Gorton (1989) also point out that excess volatility may not be necessarily avoided during the suspension since trading suspension blocks the opportunity to...
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...McNichols (1989), Dow and Gorton (1989) also point out that excess volatility may not be necessarily avoided during the suspension since trading suspension blocks the opportunity to trade....
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TL;DR: In this paper, the authors provide a critical test of the two theories using emerging market data, specifically from Egypt, and find evidence to validate both hypotheses, conditional on the regulatory regime (price limit versus circuit breaker).
Abstract: Stock market efficiency is associated with news being spread immediately in the market. The literature, however, offers two competing theories to explain this phenomenon. One theory, the mixture of distributions hypothesis (MDH) claims immediate dissemination, while the other, the sequential information arrival hypothesis (SIAH) argues for sequential dissemination, or effectively market inefficiency. The present paper provides a critical test of the two theories using emerging market data, specifically from Egypt, and finds evidence to validate both hypotheses, conditional on the regulatory regime (price limit versus circuit breaker). Using generalized method of moments estimation on 10 years of daily data on the EXG 30 market index, our results show that within the price limit window, news proxied by trading volume, spreads instantaneously to all market participants, consistently with the MDH. Within subsequent circuit breaker window, however, new information leaks out to all market participants only ove...
5 citations
Cites background or result from "Self-Generating Trade And Rational ..."
...LRS’s results are consistent with prevailing ‘learning through trading’ theories6 (e.g. Dow and Gorton 1989)....
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...The alternative hypothesis to H2 is that switching increases volatility (consistently with Subrahmanyam 1994 and Greenwald and Stein 1991) or decreases volatility (consistently with Dow and Gorton 1989)....
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TL;DR: In this article, the effects of regulatory policies such as price limit to circuit breaker on the dynamic relationship between trading volume and stock returns volatility in the EGX were investigated, and it was shown that the volume-volatility relationship is not only endogenous but is also structurally altered by the switch.
4 citations
TL;DR: In this paper, the authors apply spectrum analysis to examine the impact of price limits on stock price movements and find that price limits do alter the pattern of stock price movement in Taiwan.
Abstract: The present study applies spectrum analysis to examine the impact of price limits on stock price movements. Based on spectrum analysis, the authors find that the imposition of price limits does alter the pattern of stock price movements in Taiwan. Yet, its efficacy erodes over time.
4 citations