Speculative Trade and Market Newcomers
Abstract: Picturing that in the real world inexperienced investors may be prey for veteran traders, we give a formal sufficient condition for a speculative bubble of this type in a simple stationary model. The condition is simply that some relatively inexperienced cohort belongs to the most optimistic group but another more experienced cohort does not. This agreement to disagree leads to a perpetual bubble, in which the price overshoots the most optimistic fundamental valuation. Our condition allows the most experienced to be among the most optimistic. As in a fraction of the uniform experience literature, lack of short-selling makes room for the success of such bubble schemes. This previous literature did not allow for persistent effects of experience on beliefs and, instead, relied on more direct assumptions of belief heterogeneity. Although we map experience into beliefs in a specific way, the intuition behind the perpetual bubble involves the above-mentioned disagreement patterns, not belief formation itself.