The Price Impact and Survival of Irrational Traders






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    • Kogan and Ross are from the Sloan School of Management, MIT and NBER; Wang is from the Sloan School of Management, MIT, NBER, and China Center for Financial Research; and Westerfield is from the Marshall School of Business, University of Southern California. The authors thank Phil Dybvig, David Easley, Ming Huang, Robert Stambaugh (the editor), Wei Xiong, an anonymous referee, and participants of the 2002 NBER Asset Pricing Summer Conference, the 2003 Econometric Society Meetings, the Liquidity Conference at the London School of Economics, the 2004 American Finance Association Meetings, the 2004 Society for Economic Dynamics Meetings, and seminars at Carnegie-Mellon, Duke, London Business School, MIT, NYU, University of Geneva, University of Lausanne, University of Maryland, University of Michigan, University of Oslo, University of Vienna, and the Wharton School for comments. The authors also thank the International Center for FAME for the 2004 FAME Research Prize.


Milton Friedman argued that irrational traders will consistently lose money, will not survive, and, therefore, cannot influence long-run asset prices. Since his work, survival and price impact have been assumed to be the same. In this paper, we demonstrate that survival and price impact are two independent concepts. The price impact of irrational traders does not rely on their long-run survival, and they can have a significant impact on asset prices even when their wealth becomes negligible. We also show that irrational traders' portfolio policies can deviate from their limits long after the price process approaches its long-run limit.