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This is the email I wrote yesterday to fours authors of DSSW theory, in it I mentioned some critical ideas on this paper that I came up with and involved into my graduate paper. Although no reply until now, I still look forward to their feedback as well as discussions with audiences of this post.
Dear Professor Andrei Shleifer,
I'm Zhang Xiaoqi, a senior student in a Chinese university and will go my my graduate study in US. Since my graduate paper was chosen the topic, the evolution of investment and speculating in financial market, I studied your classical paper "Noise Trader Risk in Financial Market" in detail and came up with many interesting opinions that are very different from the viewpoints in your paper. Of course, all my critical ideas have nothing to do with my apprecation on your enlightening and original dedication to behavior finance theory, but I still believe the points I mentioned in my paper has more general implications and can pierce out some loopholes left in your paper, therefore, I hope to briefly introduce my opinions to you and if you like, we could discuss further.
My paper mainly focuses on the theme that how different exchange behaviors, investment and speculating, evolve in long term under the condition where price interacts with the behavioral structure, which seems consistent of your work, but should be distinguished by two key assumptions, the definition about speculating behavior and the pricing mechanism. In specific,
1)
Speculating behavior is a kind of exchange strategy used by investors in stock market, by which investors based on the historical fluctuation of price make prediction of the future yields as well as the decision of exchange direction and quantity. Essentially, speculating behavior is equivalent to momentum investors defined in DHS, HS, BSV models. Noticed that speculating here involves totally different features comparing to your noisy trade behavior, since in your theory, although the ratio between noisy trader and rational investors need to be determined internally, the misperception is definitely an external variable, in contrast, speculating in my model implies the pure internalization of both variables, the ratio among behaviors and the misperception. Afterward, through introducing the conclusion drawn by my model, you can see the externalized misperception has extremely narrowed down the comparative advantages the irrational exchange behavior, like speculating, has in contrast to rational investment.
2)
Price in my model is not determined by the clearing condition, or say the equilibria price is the one when demand of stock equal to its supply in each time period, instead, I adopt the mechanism used by Keynesian economic model, where the price is generated by the net demand of stock in each time. To make this assumption reasonable, I mainly consider two facts, firstly, from the observation of data about exchange amount, there are always large gap between demand and supply and it can always last for long time, meanwhile, vary in some certain and predictable ways, clearing condition doesn’t match this empirics. Secondly, as Peyton Young said, neoclassical theory see what happened after all things done, but evolutionary theory pay attention to what happened before that and how all things done, in the same way, although the price tends to regress if we see long-term data, the evolution of behavior has no reason only to occur when clearing condition is met, so it’s not for sure that the stable behavioral structure deduced from a non-clearing market is equivalent to that from always clearing market. Actually in my opinion, the clearing condition plays as the same role as external misperception to reduce the comparative advantage of some certain kinds of irrational behavior, like speculating.
With above key assumptions and the traditional definition of rational investors who make hedging when price deviate from its internal value, it can be founded easily how people make selection between rational investment and speculating as a simply dynamic replica process, in which the behavior brought positive yields to investors in history would be strengthened to a certain degree and caused negative yields would be reduced.
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