Speculation

Abstract: Analyses of the role of rational speculators in financial markets usually presume that such investors dampen price fluctuations by trading against liquidity or noise traders This conclusion does not necessarily hold when noise traders follow positive-feedback investment strategies buy when prices rise and sell when prices fall In such cases, it may pay rational speculators to try to jump on the bandwagon early and to purchase ahead of noise trader demand If rational speculators' attempts to jump on the bandwagon early trigger positive-feedback investment strategies, then an increase in the number of forward-looking rational speculators can lead to increased volatility of prices about fundamentals

Abstract: Analyses of rational speculation usually presume that it dampens fluctuations caused by "noise" traders. This is not necessarily the case if noise traders follow positivefeedback strategies-buy when prices rise and sell when prices fall. It may pay to jump on the bandwagon and purchase ahead of noise demand. If rational speculators' early buying triggers positive-feedback trading, then an increase in the number of forwardlooking speculators can increase volatility about fundamentals. This model is consistent with a number of empirical observations about the correlation of asset returns, the overreaction of prices to news, price bubbles, and expectations. WHAT EFFECT DO RATIONAL speculators have on asset prices? The standard answer, dating back at least to Friedman (1953), is that rational speculators must stabilize asset prices. Speculators who destabilize asset prices do so by, on average, buying when prices are high and selling when prices are low; such destabilizing speculators are quickly eliminated from the market. By contrast, speculators who earn positive profits do so by trading against the less rational investors who move prices away from fundamentals. Such speculators rationally counter the deviations of prices from fundamentals and so stabilize them. Recent work on noise trading and market efficiency has accepted this argument (Figlewski, 1979; Kyle, 1985; Campbell and Kyle, 1988; DeLong, Shleifer, Summers, and Waldmann, 1987). In this work, risk aversion keeps rational speculators from taking large arbitrage positions, so noise traders can affect prices. Nonetheless, the effect of rational speculators' trades is to move prices in the direction of, even if not all the way to, fundamentals. Rational speculators buck noisedriven price movements and so dampen, but do not eliminate, them. In this paper we present a possibly empirically important exception to this argument, based on the prevalence of positive feedback investors in financial markets. Positive feedback investors are those who buy securities when prices rise and sell when prices fall. Many forms of behavior common in financial markets can be described as positive feedback trading. It can result from extrapolative expectations about prices, or trend chasing. It can also result from stoploss orders, which effectively prompt selling in response to price declines. A

Abstract: We propose a cross-sectional time-series model to assess the impact of market lib- eralizations in emerging equity markets on the cost of capital, volatility, beta, and correlation with world market returns. Liberalizations are defined by regulatory changes, the introduction of depositary receipts and country funds, and structural breaks in equity capital flows to the emerging markets. We control for other eco- nomic events that might confound the impact of foreign speculators on local equity markets. Across a range of specifications, the cost of capital always decreases after a capital market liberalization with the effect varying between 5 and 75 basis points. THROUGHOUT HISTORY AND IN MANY MARKET ECONOMIES, the speculator has been characterized as both a villain and a savior. Indeed, the reputation of the speculator generally depends on the country where he does business. In well- functioning advanced capital markets, such as the United States, the specu- lator is viewed as an integral part of the free-market system. In developing capital markets, the speculator, and in particular the international specula- tor, is looked upon with many reservations. Recently, many so-called "emerging" markets have opened up their capital markets to foreign investors, creating an ideal laboratory for examining the impact of increased foreign portfolio investment in developing equity mar- kets. Our main focus is the impact on expected equity returns-the cost of equity capital. However, we also examine the effects of increased foreign

Abstract: A number of countries have delayed the opening of their capital markets to international" investment because of reservations about the impact of foreign speculators on both expected" returns and market volatility. We propose a cross-sectional time-series model that attempts to" assess the impact of market liberalizations, in the form of the offering of depositary receipts country funds and other financial instruments, in an extranational market and market volatility in emerging equity markets. We also examine the impact of capital market" liberalizations on the correlation of emerging equity market returns and the world market return. " Our empirical approach is designed to control for other economic events which might confound" the impact of foreign speculators on local equity markets. Whatever the empirical specification the cost of capital always decreases after a capital market liberalization but the effect is" economically and statistically weak. The effects on volatility and correlation are less robust."