Trading Frenzies and Their Impact on Real Investment

Publication Date
Financial Markets Group Discussion Papers DP 670
Publication Date
Paul Woolley Centre Discussion Papers No 20
Publication Authors

We study a model where a capital provider learns from the price of a firm’s security in deciding how much capital to provide for new investment. This feedback effect from the financial market to the investment decision gives rise to trading frenzies, where speculators all wish to trade like others, generating large pressure on prices. Coordination among speculators is sometimes desirable for price informativeness and investment efficiency, but speculators’ incentives push in the opposite direction, so that they coordinate exactly when it is undesirable. We analyze the effect of various market parameters on the likelihood of trading frenzies to arise.


This discussion paper won a Paul Woolley Centre discussion paper prize.