Herd on the Street: Informational Inefficiencies in a Market with Short-Term Speculation

Authors

  • KENNETH A. FROOT,

  • DAVID S. SCHARFSTEIN,

  • JEREMY C. STEIN

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    • From Harvard University and NBER, Massachusetts Institute of Technology (MIT) and NBER, and MIT and NBER respectively. We thank Mike Fishman, Greg Mankiw, Stew Myers, Andre Perold, Julio Rotemberg, Andrei Shleifer, and seminar participants at numerous institutions for helpful comments. We are also grateful for research support from the Olin and Ford Foundations, MIT's International Financial Services Research Center, Batterymarch Financial Management, and the Division of Research at Harvard Business School.

ABSTRACT

Standard models of informed speculation suggest that traders try to learn information that others do not have. This result implicitly relies on the assumption that speculators have long horizons, i.e., can hold the asset forever. By contrast, we show that if speculators have short horizons, they may herd on the same information, trying to learn what other informed traders also know. There can be multiple herding equilibria, and herding speculators may even choose to study information that is completely unrelated to fundamentals.

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