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  3. American Economic Review
  4. December 2015
  5. Feedback Effects, Asymmetric Trading, and the Limits to Arbitrage

Feedback Effects, Asymmetric Trading, and the Limits to Arbitrage

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Abstract

We analyze strategic speculators' incentives to trade on information in a model where firm value is endogenous to trading, due to feedback from the financial market to corporate decisions. Trading reveals private information to managers and improves their real decisions, enhancing fundamental value. This feedback effect has an asymmetric effect on trading behavior: it increases (reduces) the profitability of buying (selling) on good (bad) news. This gives rise to an endogenous limit to arbitrage, whereby investors may refrain from trading on negative information. Thus, bad news is incorporated more slowly into prices than good news, potentially leading to overinvestment. (JEL D83, G12, G14)

Citation

Edmans, Alex, Itay Goldstein, and Wei Jiang. 2015. "Feedback Effects, Asymmetric Trading, and the Limits to Arbitrage." American Economic Review, 105 (12): 3766-97. DOI: 10.1257/aer.20141271

Additional Materials

JEL Classification

  • D83 Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
  • G12 Asset Pricing; Trading Volume; Bond Interest Rates
  • G14 Information and Market Efficiency; Event Studies; Insider Trading