Working Paper: NBER ID: w3250
Authors: Kenneth A. Froot; David S. Scharfstein; Jeremy C. Stein
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. These equilibria are informationally inefficient.
Keywords: informational inefficiencies; short-term speculation; herding behavior
JEL Codes: G14; D82
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| short-term speculation (D84) | decreased informational efficiency (D83) |
| short-horizon traders herd on information (G14) | multiple herding equilibria (C92) |
| multiple herding equilibria (C92) | informational inefficiency (D83) |
| short-term speculators study low-quality information (D84) | concentration of research efforts (D29) |
| traders coordinate research on same information (F10) | improve collective outcomes (D70) |
| herding behavior (C92) | neglect of relevant data (C52) |
| herding behavior (C92) | impact on market outcomes (F61) |