Positive Feedback Investment Strategies and Destabilizing Rational Speculation

Authors

  • J. BRADFORD DE LONG,

  • ANDREI SHLEIFER,

  • LAWRENCE H. SUMMERS,

  • ROBERT J. WALDMANN

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    • De Long is from Harvard University and NBER; Shleifer is from University of Chicago and NBER; Summers is from Harvard University and NBER; Waldmann is from European University Institute. We would like to thank the Russel Sage and Alfred P. Sloan Foundations for financial support and Robert Barsky, Oliver Hart, Kevin Murphy, Jeremy Stein, Hans Stoll, René Stulz, and Robert Vishny for helpful comments.

ABSTRACT

Analyses of rational speculation usually presume that it dampens fluctuations caused by “noise” traders. This is not necessarily the case if noise traders follow positive-feedback strategies—buy when prices rise and sell when prices fall. It may pay to jump on the bandwagon and purchase ahead of noise demand. If rational speculators' early buying triggers positive-feedback trading, then an increase in the number of forward-looking speculators can increase volatility about fundamentals. This model is consistent with a number of empirical observations about the correlation of asset returns, the overreaction of prices to news, price bubbles, and expectations.

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