The Behavior of Financial Markets under Rational Expectations

Description

The financial markets have become more and more important in modern society. The behavior of the financial markets, and its impacts on our society, relies crucially on the behavior of market participants, aka the investors of different types. Although descriptions of the financial markets on the macro level have caught great attentions of investors, regulators, and the ordinary people, how the market participants interact with each other in the financial market may provide deeper insights on how and why the financial markets behave. This book tries to supply as much research on the micro level of financial market behavior as possible to the readers. The author has been doing financial research, especially on the micro level, during the past two decades. The academic research on this broad area has undergone a rapid growth, with new results, methods, theories, and even paradigms, emerging and burgeoning almost every year. As a financial researcher in one of China’s top universities, the author has kept monitoring, digesting, and synthesizing the research articles in the area. This book is the outcome of this decades-long routine research work of the author. The book covers the fundamental economic theories of how different investors receive and interpret information. The empirical results of investors behavior are also discussed in depth. The book also shows the basic academic techniques of modeling the investors behavior. Table of Contents 1 Information 1.1 Rational expectations 1.2 Different opinions 1.3 Information Aggregation and learning 1.4 How do Agents Learn New Information 1.5 Information and pricing 1.6 Further issues of learning and reacting 1.7 Information providers 2 How are Prices Formed? 2.1 The Perspective of Asset Pricing Literature 2.2 Inventory Costs Based Microstructure Models 2.3 Information Based Microstructure Models 2.4 What is Risk? 2.5 Trading mechanism . 2.6 Short selling 2.7 Other Topics in Microstructure 3 Liquidity 17 3.1 Measuring Liquidity 3.2 Volume . 3.3 Determinants of Liquidity 3.4 Market’s and Liquidity Providers’ Conditions and Liquidity 3.5 The Effect of Liquidity on the Firm’s Well Beings 3.6 Who is Providing Liquidity 4 Limit Orders 4.1 The Models of Limit Orders 4.2 Investor’s Choice of Limit versus Market Orders 4.3 Limit Order Revisions and Aggressiveness 4.4 Limit Order Patterns . 5 Depicting investors 5.1 Theory Based Investor Taxonomy 5.2 Identity Based Investor Taxonomy 5.3 Investor sophistication 5.4 Herding and correlated trading . 5.5 Trading behavior 6 Mutual Funds 6.1 Fund Performance and Fund Manager Skills 6.2 Funds herding . 6.3 Incentives and the risk shifting 6.4 Fund Flow and Investor’s Preferences 6.5 Fund Fees 6.6 Governance of Funds 7 Prices of IPO and SEO 46 7.1 Why and When to Issue New Equities 7.2 Choice of Issue Types . 7.3 New Issuance Pricing . . 7.4 Trading around IPO and SEO 7.5 Market Reaction and Long Term Performance 8 Behavioral Explanation 51 8.1 General discussion on the behavioral explanation . 8.2 Disposition effect and prospect theory 8.3 Overconfidence and Over-reaction 8.4 Awareness, familiarity, and Attention . 8.5 Law of small numbers 8.6 Rational structural uncertainty models 9 Modeling economic behavior 9.1 Nash Equilibrium 9.2 Bayesian Games 9.3 Utility maximization models 10 Mathematical Techniques for Economic Modeling 64 10.1 Difference Equations 10.2 Differential Equations 10.3 Fixed Point 10.4 Static Optimization 10.5 Duality 11 Empirical Methodology 11.1 Regressions 11.2 Non-Regression Methods 11.3 Endogeneity 11.4 Measurements Bibliography Cover Book Title Copyright Contents Chapter 1 Information 1.1 Rational expectations 1.2 Different opinions 1.3 Information aggregation and learning 1.3.1 Information percolation and learning 1.3.2 Hidden information 1.3.3 Price informativeness 1.4 How do agents learn new information 1.5 Information and pricing 1.5.1 Information asymmetry and asset pricing 1.5.2 Liquidity and asset pricing 1.6 Further issues of learning and reacting 1.7 Information providers Chapter 2 How are prices formed? 2.1 The perspective of asset pricing literature 2.2 Inventory costs based microstructure models 2.3 Information based microstructure models 2.4 What is risk? 2.5 Trading mechanism 2.6 Short selling 2.7 Other topics in microstructure Chapter 3 Liquidity 3.1 Measuring liquidity 3.2 Volume 3.3 Determinants of liquidity 3.4 Markets’ and liquidity providers’ conditions and liquidity 3.5 The effect of liquidity on the firm’s well-being 3.6 Who is providing liquidity Chapter 4 Limit orders 4.1 The models of limit orders 4.2 Investor’s choice of limit versus market orders 4.3 Limit order revisions and aggressiveness 4.4 Limit order patterns Chapter 5 Depicting investors 5.1 Theory based investor taxonomy 5.1.1 Informed investors 5.1.2 Liquidity investors, noise investors, and speculators 5.2 Identity based investor taxonomy 5.2.1 Individual investors 5.2.2 Institutional investors 5.2.3 Foreign investors 5.3 Investor sophistication 5.3.1 What does sophistication mean? 5.3.2 The effect of investor sophistication 5.4 Herding and correlated trading 5.4.1 Empirical evidence 5.4.2 Theoretical explanations 5.5 Trading behavior 5.5.1 Trading and contemporaneous returns 5.5.2 Trading horizon 5.5.3 Value investing Chapter 6 Mutual funds 6.1 Fund performance and fund manager skills 6.1.1 Overview of fund manager skills 6.1.2 Factors affecting fund performance 6.2 Funds herding 6.3 Incentives and the risk shifting 6.4 Fund flow and investor’s preferences 6.4.1 Flow-performance relationship 6.4.2 Explanations for asymmetric performance-flow relationship 6.4.3 Investor’s purchasing process 6.4.4 Advertising 6.4.5 Smart or dumb money effect 6.5 Fund fees 6.6 Governance of funds Chapter 7 Prices of IPO and SEO 7.1 Why and when to issue new equities 7.2 Choice of issue types 7.3 New issuance pricing 7.4 Trading around IPO and SEO 7.5 Market reaction and long term performance Chapter 8 Behavioral explanation 8.1 General discussion on the behavioral explanation 8.2 Disposition effect and prospect theory 8.3 Overconfidence and over-reaction 8.4 Awareness, familiarity, and attention 8.5 Law of small numbers 8.6 Rational structural uncertainty models Chapter 9 Modeling economic behavior 9.1 Nash equilibrium 9.1.1 Dominant and dominated strategy 9.1.2 Definition of Nash equilibrium 9.1.3 Evolutionary stability 9.1.4 Continuous strategy space 9.2 Bayesian games 9.3 Utility maximization models Chapter 10 Mathematical techniques for economic modeling 10.1 Difference equations 10.2 Differential equations 10.2.1 Existence and uniqueness of the solutions 10.2.2 Solving one-variable first-order differential equation 10.2.3 General method solving high order linear differential equations 10.3 Fixed point 10.4 Static optimization 10.5 Duality Chapter 11 Empirical methodology 11.1 Regressions 11.1.1 Simple regressions 11.1.2 Regression discontinuity 11.1.3 Ordered probit regression 11.1.4 Vector autoregression 11.1.5 Panel data regressions 11.2 Non-regression methods 11.3 Endogeneity 11.3.1 Natural experiment 11.3.2 Difference approach 11.3.3 Instrumental variables 11.3.4 Simultaneous equations 11.3.5 Self-selection and Heckman model 11.3.6 Smart experimental designs getting around endogeneity 11.3.7 When should we be concerned about endogeneity 11.3.8 Other research design issues 11.4 Measurements 11.4.1 Sample and data 11.4.2 Information and risk 11.4.3 Trading 11.4.4 Firm characteristics 11.4.5 Asset pricing related measures Bibliography Backcover