Research Talk for October 18, 2019
Informed speculation with k-level reasoning
Hang Zhou, UC Davis
October 18, 2019
UW Bothell main campus
This paper studies the effect of strategic reasoning on financial markets by revisiting the micro structure model à la Kyle (1989) with the level-k reasoning framework. A level-k speculator performs k rounds of iterative reasoning to infer information from asset price. In contrast to symmetric Bayesian Nash equilibrium, the level-k framework explains the coexistence of momentum and contrarian trading strategies. As for market implication, this paper discusses how the distribution of reasoning levels affects macro variables and sheds new light on empirical puzzles such as: (1) overvaluation of assets, (2) extra price volatility and (3) excessive trading volume.
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