Sentiment and speculation in a market with heterogeneous beliefs

Ian W. R. Martin, Dimitris Papadimitriou

Research output: Contribution to journalArticlepeer-review

5 Citations (Scopus)
104 Downloads (Pure)

Abstract

We present a model featuring risk-averse investors with heterogeneous beliefs. Individuals who are correct in hindsight—whether through luck or judgment—get rich, so sentiment is bullish following good news and bearish following bad news. Sentiment creates excess volatility, has asymmetric effects on left/right-skewed assets, and makes extreme outcomes more important. Investors take speculative positions that can conflict with their fundamental views. Ex ante, they all view speculation as socially costly; ex post, the average investor regrets having speculated. But every investor thinks speculation is in his or her self-interest, and the market can collapse entirely if speculation is banned.
Original languageEnglish
Pages (from-to)2465-2517
JournalAMERICAN ECONOMIC REVIEW
Volume112
Issue number8
Early online date11 Mar 2022
DOIs
Publication statusPublished - Aug 2022

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