Price Discovery in the Presence of Boundedly Rational Agents

37 Pages Posted: 22 Jun 2003

See all articles by Karl Ludwig Keiber

Karl Ludwig Keiber

European University Viadrina Frankfurt (Oder) - Department of Economics

Date Written: January 2003

Abstract

In this paper we propose a sequential model of security trading which, compared to existing models, is extended along the notions of Simon (1995), Rubinstein (1998) and Odean (1999) by adding boundedly rational traders. Our results indicate that both momentum and mean-reversion in asset prices can be attributed to the presence of agents who are subject to systematic errors in the process of forecasting the liquidation value of a risky security. The length of the momentum period is inversely related to both the amount of information-based trading in the market and the rate at which asset specific information is learned by boundedly rational agents. Furthermore, the model allows explicitly to establish a link between the component of the bid-ask spread that can be explained by bounded rationality and both momentum and reversal.

JEL Classification: D4, D8, G1

Suggested Citation

Keiber, Karl Ludwig, Price Discovery in the Presence of Boundedly Rational Agents (January 2003). Available at SSRN: https://ssrn.com/abstract=407783 or http://dx.doi.org/10.2139/ssrn.407783

Karl Ludwig Keiber (Contact Author)

European University Viadrina Frankfurt (Oder) - Department of Economics ( email )

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D-15230 Frankfurt (Oder)
Germany
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+49-335-55342357 (Fax)

HOME PAGE: http://www.wiwi.euv-frankfurt-o.de/keiber

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