Predatory Trading

This paper studies predatory trading: trading that induces and/or exploits other investors' need to reduce their positions. We show that if one trader needs to sell, others also sell and subsequently buy back the asset. This leads to price overshooting, and a reduced liquidation value for the distressed trader. Hence, the market is illiquid when liquidity is most needed. Further, a trader prots from triggering another trader's crisis, and the crisis can spill over across traders and across assetsasset pricing

Do Wealth Fluctuations Generate Time-varying Risk Aversion? Micro-Evidence on Individuals' Asset Allocation

We use data from the PSID to investigate how households' portfolio allocations change in response to wealth fluctuations. Persistent habits, consumption commitments, and subsistence levels can generate time-varying risk aversion with the consequence that when the level of liquid wealth changes, the proportion a household invests in risky assets should also change in the same direction. In contrast, our analysis shows that the share of liquid assets that households invest in risky assets is not affected by wealth changes. Instead, one of the major drivers of households' portfolio allocation seems to be inertia: households rebalance only very slowly following inflows and outflows or capital gains and losses.

Buy on rumours - sell on news: a manipulative trading strategy

A trader who receives a signal about a future public announcement can exploit this private information twice. First, when he receives his signal, and second, at the time of the public announcement. The second round advantage occurs because the early-informed trader can best infer the extent to which his information is already reflected in the current price. This paper shows that early-informed traders trade very aggressively at the time they receive their signal. They try to manipulate the price in order to enhance their informational advantage at the time of the public announcement. In addition, they speculate by building up a position in period one, which they partially unwind 'on average' in period tow. The analysis shows that informational leakage makes prices prior to public announcements more informative but reduces informational efficiency in the long run

Optimal Expectations

This paper introduces a tractable, structural model of subjective beliefs. Since agents that plan for the future care about expected future utility flows, current felicity can be increased by believing that better outcomes are more likely. On the other hand, expectations that are biased towards optimism worsen decision making, leading to poorer realized outcomes on average. Optimal expectations balance these forces by maximizing the total well-being of an agent over time. We apply our framework of optimal expectations to three different economic settings. In a portfolio choice problem, agents overestimate the return of their investment and under diversify. In general equilibrium, agents’ prior beliefs are endogenously heterogeneous, leading to gambling. Second, in a consumption-saving problem with stochastic income, agents are both overconfident and overoptimistic, and consume more than implied by rational beliefs early in life. Third, in choosing when to undertake a single task with an uncertain cost, agents exhibit several features of procrastination, including regret, intertemporal preference, reversal, and a greater readiness to accept commitment.Expectations formation, beliefs, overconfidence, wishful thinking, procrastination, gambling

Optimal Expectations

This paper introduces a tractable, structural model of subjective beliefs. Since agents that plan for the future care about expected future utility flows, current felicity can be increased by believing that better outcomes are more likely. On the other hand, expectations that are biased towards optimism worsen decision making, leading to poorer realized outcomes on average. Optimal expectations balance these forces by maximizing the total well-being of an agent over time. We apply our framework of optimal expectations to three different economic settings. In a portfolio choice problem, agents overestimate the return of their investment and underdiversify. In general equilibrium, agents' prior beliefs are endogenously heterogeneous, leading to gambling. Second, in a consumption-saving problem with stochastic income, agents are both overconfident and overoptimistic, and consume more than implied by rational beliefs early in life. Third, in choosing when to undertake a single task with an uncertain cost, agents exhibit several features of procrastination, including regret, intertemporal preference reversal, and a greater readiness to accept commitment.expectations formation, beliefs, overconfidence

Market Liquidity and Funding Liquidity

We provide a model that links an asset's market liquidity - i.e., the ease with which it is traded - and traders' funding liquidity - i.e., the ease with which they can obtain funding. Traders provide market liquidity, and their ability to do so depends on their availability of funding. Conversely, traders' funding, i.e., their capital and the margins they are charged, depend on the assets' market liquidity. We show that, under certain conditions, margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals. The model explains the empirically documented features that market liquidity (i) can suddenly dry up, (ii) has commonality across securities, (iii) is related to volatility, (iv) is subject to "flight to quality", and (v) comoves with the market, and it provides new testable predictions.

Predatory Trading

This paper studies predatory trading: trading that induces and/or exploits other investors' need to reduce their positions. We show that if one trader needs to sell, others also sell and subsequently buy back the asset. This leads to price overshooting and a reduced liquidation value for the distressed trader. Hence, the market is illiquid when liquidity is most needed. Further, a trader profits from triggering another trader's crisis, and the crisis can spill over across traders and across markets.