Speculative Investor Behaviour in a Stock Market with Heterogeneous Expectations - Book Report/Review Example

Research paper review Harrison, M. and Kreps, D. “Speculative Investor Behaviour in a Stock Market with Heterogeneous Expectations” Review of the relevant and accompanying literature According to recent evidences and statistics on financial engineering and financial management perspective, the research carried out by J.M.Harrison and D.M.Kreps aims at investigating the investors behavior on a broader basis, together with an accurate analysis of the major ongoing trends and aspects in the investment arena. In this sense major works that have been analyzed ant taken into account for this work are the following ones: Feiger (1976) and Hirshleifer (1975) for what concerns the characterization of speculative behaviors and partial equilibrium frameworks in this sense, in order to explain all the cases in which the market momentum allows to pay more for an asset than what an investor would pay to retain that asset itself for an indefinite amount of time. In the second work, more precisely, a detailed and accurate analysis on the major factors that are taken into account when partial equilibrium take place, market transparency has been found to be a positive and statistically significant variable for the research. Radner (1972): this research is cited mainly for what is related to its model implemented for reaching a definition of consistent price schemes, in light of the co-existence of multiple asset classes. The same work has been considered also in light of its definition of “partial equilibrium” prices; Under the assumption of perfect contingent foresight, the author assumes that elements such as the quality of data and a solid quantitative basis and modeling capability can make possible to estimate perfect prices also in imperfect markets. Chung (1974) as an hypothesis for the Proposition 1, where speculative prices are intended as outcomes of a “fair” game, with main actions (and variable) intended as buy, sell and hold. The probabilistic approach highlighted in this work makes possible for the author of the research paper to infer some major technical and quantitative elements that support the probabilistic approach on the outcome of speculative investment approaches in the market. J.B.Williams (1938): in this work the author firstly considered the intrinsic value of a share for a company as dependent on the company’s capacity to pay dividends, so that the higher the dividend, the higher the stock price should be. A similar reasoning has been carried out some decades later by Gordon; nowadays there is no doubt on the interdependence between dividend consistence, dividend growth and their positive externalities on share price, and consensus has been found on a broader basis in support of this hypothesis. Beja (1976): in this analysis, the author firstly assumed that investors act in light of the information they retain, and therefore, an accurate investigation of the factors influencing the share price reaction to news and information should be properly assessed. A broader outcome of this study consists in the belief that prices reflect information in order to induce identical actions by investors. Arrow (1978): this work has been cited for this research since the analysis carried out in this paper makes possible to infer that risk management and risk considerations are usually primarily regarded on an investment perspective: prices capacity to embed and reflect risk information is therefore seen as a necessary element for a realistic investor. With the exception of speculative investors, other types of investors are found to be completely risk adverse, with different specific sensitivities to the main risk factors in this sense. The research paper considered for this review is based therefore on solid and detailed probabilistic methods and theories, that make possible to assume the broad scope of the assumptions and of the considerations highlighted with the research propositions. Paper assessment and review This work sheds light on the major issues emerging from the speculative behavior effects on a broader investment based analysis of the financial markets: under the assumption of perfect markets, the main hypotheses concerning the investment technical approaches are fully respected and have already been analyzed by the Body of Literature on an extensive and comprehensive basis. On the other side, when there are major realistic hypotheses under consideration, the theory can be challenged on a more analytical basis, such as, for instance, the dividend volatility can be impaired, and the share owner’s right on them as well. The main characteristics of imperfect markets reflect the state of the art, and the realistic approach of many analyses in this field: the primary goal of investor becomes profit oriented, and in this sense the appearance of speculative phenomena can become reality, with investors willing to pay for an asset more than what it would have been paid by rational investors with long term objectives, and therefore more willing to follow temporary and unrealistic trends in light of less quantitative and more personal instinctive approaches in this sense. A simple model is presented, with major assumptions that are shared by the Body of literature: in order to highlight a partial equilibrium framework, certain technical aspects are analyzed, so that to certain extents speculative behavior is not considered as an “all-inclusive” one. Other sections of the work aim to assess a comprehensive role of heterogeneous expectations, so that the investors are qualified in light of major models that take into account homogeneous classes of wealth levels, and all kind of investors have access to the same information level. Numerical examples are highlighted on a general basis, where prices follow a martingale like probabilistic distribution, and buy an asset with a speculative premium to certain extents when market rationales are given on additional purposes. Generally speaking, a major hypothesis in this field has been the one that states how minimal consistent prices of speculative investors will exceed every investor’s expected price as a present value of the sum of all future dividend streams, so that investors tend to spend for an additional speculative premium because of anticipated capital gains, on a not minimal price scheme. In this model, short speculative restrictions are cancelled, while technical analyses and random walk hypotheses can be considered as complementary alternatives to the random walk hypothesis. In the formulation of the major model, this paper tend to favor a probabilistic and quantitative approach where all dividends are not negative and are declared just before they are released on an homogeneous basis. The total information set at disposal for investors is efficient and comprehensive, so that the model formulation, for the time periods considered, takes into account a vector for the economic information made available in this sense. Market activities and operations, in this model, take place at discrete time intervals, so that to certain extents they are affected by market information on a regular basis. The vector of information collects a serie of time dependent variables, called with the X variable, while dividends in this field are indicated as d(x), stressing therefore the direct relation between dividend, amounts of money, and amounts of information as well. Another major hypothesis of this model states that investors do not have the control of information, so that corporations and investors in this way follow complementary but paralleling environmental patterns. All investors are believed to be risk neutral, and discount future money and cash flows with a proper discount rate Sigma, so that time value of money is reflected in the analytical computations as well. Stocks cannot be sold on short, and risk classes determine the quality and characteristics of each investor. In the simplified model, investors are comprehended in 2 classes, where information at disposal is combined properly on an analytical basis. Probability measures and class data are positive and designed so that frequency data cannot alter their assessment. The model searches then to assess a current state of the market in order to determine the right stock price, in light of the positive given discount factor. A successful approach of this model lies then in the fact that a feasibility analysis is carried out, so that at any point the realistic approach designed on a quantitative basis is suited to infer whether the price set as an outcome of the model follows realistic assumptions and deterministic hypotheses. Price schemes are defined on a general basis, and on a theoretical perspective they reflect partial economic histories of the corporations for which they are designed. Legitimate selling strategies are inferred in a proper way, so that present values for the investment strategies relative to certain investors on a personal basis are inferred, and perfect contingent foresights are determined in compliance with a wide array of imperfect future markets. Conceptions in this sense are carefully noted and future prices are negotiated on a consistent and statistically significant basis. The model then sets comprehensive and well-designed propositions in order to compute and reach a proper market equilibrium for assets negotiated within the analyzed markets. Briefly speaking, major propositions in the model: Proposition 1: A price scheme P(t) is consistent only and only if for all t and x(t), the following equation is verified: Non anticipatory strategies in this sense are believed to be better suited than “break even” strategies, as far as stopping times are permitted. In few words, for accurate investors it will be always possible to carry out strategies whose aim is to generate positive Net Present Values by simply enacting actions such as buying an asset, holding it and selling it on a different time. Proposition 2: If the price scheme P*(t) verified under the equilibrium conditions is consistent, then for any other p(t) it is always verified that p(t) > p*(t). In a natural investment horizon called”n”, it will always exist a not minimal price so that its present value is higher than the equilibrium one. A consistent price in this field has therefore to be as large or even larger than the investor’s present value of expected future dividend flows. Proposition 3: where on the other side an unique investor class “a” exists, then the minimal consistent price scheme p*(t) can be finite only when the Z(t) non negative martingale holds, and more in details, a monotone converge takes place, so that the following formula holds: The stationary nature of the example makes possible to assume that a monotonically increasing price structure can yield to the previously described price limit as firstly assumed, as far as n tends to infinite. The crucial assumption of short sales forbidden is therefore in this sense a necessary condition in order for the price limit assumption for equilibrium to hold: when this hypothesis holds, the investors of the more risk adverse classes will held more asset classes in this sense. Streams stemming from speculative strategies in this sense are properly assessed on a clear quantitative basis, and in this area a proper effective speculative behavior can lead to future expected streams of revenues that can not only be quantified on a proper basis, but also be evaluated, so that certain speculative strategies can be carried out on a consistent approach when their present value meets the assumption of positive value ( NPV > 0). Aversion to risk can be therefore seen not just as a detrimental factor for investment strategies, but also as a necessary and fine condition for speculative investors to carry out their strategic objectives extensively. Within finite time horizon settings, this price system makes possible to adapt a fundamentalist spirit to the corporations, and in these terms the benefits for the analysis given by the aggregation of different aspects and investor classes can be clear and very high. In addition to this, there is a clear and vast consensus for the belief that market data aggregation can play a pivotal role for the major technical aspects of the competitive interplay, and in this perspective, the presence of complete aggregate information steps and levels can yield to prices that approximate the equilibrium ones. Elements and behaviors such as the speculation and the active portfolio management capabilities are in this sense necessary and subjective elements and behaviors that emerge on a discretionary basis as consequence of the major characteristics of the financial markets in which investors operate. Conclusion This research sets a comprehensive and accurate overview of the existing challenges for speculative oriented investors in the current financial management arena: in light of the works carried out by authors and researchers on an academic perspective, such as Arrow (1968), Beja (1976) and Radner (1972), a detailed, analytical and quantitative based analysis of the main reasons and elements that motivate speculative behaviors are carried out. Major assumptions in this sense are represented by the core belief that short sales for this model are forbidden, that time steps are discrete, and the information made available by corporations is extensively released at disposal of investors on an homogeneous basis. Other important elements that are used as assumptions for the model lie in the possibility to integrate and consider investors as within risk classes, and in the capability to assume prices as at least equal, or most of the times major than the present value of future dividend flows. Three important propositions retain the major outcome of the research, and indicate that from one side, price schemes developed under these assumptions are superior to the minimum equilibrium price, and on the other side consistent price scheme p*(t) can be finite only when the Z(t) non negative martingale holds. In light of these results, it’s therefore possible to infer how speculation and active forms of portfolio management are important elements that are intended as consequences of the interplay of the given factors. References Arrow, K. J. (1968). Essays in the Theory of Risk-Bearing. Chicago: Markham Publishing Company Beja, A. (1976). "The Limited Information Efficiency of Market Processes," unpublished manuscript Chung, K. L. (1974). A First Course in Probability. 2nd ed. New York: Harcourt, Brace and World Hirshleifer, J. (1975). "Foundations of the Theory of Speculation: Information, Risk, and Markets," this Journal, LXXXIX Radner, R. (1972). "Existence of Equilibrium Plans, Prices, and Price Expectations in a Sequence of Markets," Econometrica, XL, No. 2 Williams, J. B. (1938). The Theory of Investment Value. Cambridge: Harvard University Press. Keynes, J. M. (1931). The General Theory. New York: Harcourt, Brace and World Read More