Informed speculation with k-level reasoning

• 成果类型: Article
• 署名作者: Zhou, Hang
• 署名单位: Shanghai University of Finance & Economics
• 刊物名称: JOURNAL OF ECONOMIC THEORY
• ISSN/ISSBN: 0022-0531
• DOI: 10.1016/j.jet.2021.105384
• 发表日期: 2022
• 关键词: Level-k thinking; Investors' sophistication; Market instability

摘要

This paper investigates the effect of strategic reasoning on financial markets with a level-k thinking framework. A level-k speculator performs k rounds of iterative reasoning to infer information from asset prices. In contrast to the static rational expectations equilibrium, the level-k framework produces a unified theory of momentum and contrarian trading strategies. Besides, this paper discusses how the distribution of sophistication levels affects several market variables and it sheds new light on empirical patterns such as: (1) overreaction of asset prices, (2) the excess volatility puzzle, and (3) the excessive trading volume puzzle. Moreover, this paper explores whether the level-k strategy converges to the rational expectations equilibrium. (c) 2021 Elsevier Inc. All rights reserved.