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Irrational Market Makers

Author

Listed:
  • Fabrice Rousseau

    (Department of Economics, Finance and Accounting, Maynooth University.)

  • Laurent Germain

    (University of Toulouse Toulouse Business SchoolISAE)

  • Anne Vanhems

    (University of Toulouse Toulouse Business SchoolTSE)

Abstract
We analyze a model where irrational and rational informed traders exchange a risky asset with irrational market makers. Irrational traders misperceive the mean of prior information (optimistic/pessimistic bias) and the variance of the noise in their private signal (overconfidence/underconfidence bias). Irrational market makers misperceive both the mean and the variance of the prior information. We show that moderately underconfident traders can outperform rational ones and that irrational market makers can fare better than rational ones. Lastly, we find that extreme level of confidence implies high trading volume.

Suggested Citation

  • Fabrice Rousseau & Laurent Germain & Anne Vanhems, 2013. "Irrational Market Makers," Economics Department Working Paper Series n261-13.pdf, Department of Economics, National University of Ireland - Maynooth.
    • Handle: RePEc:may:mayecw:n261-13.pdf
    as

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    File URL: http://repec.maynoothuniversity.ie/mayecw-files/N261-13.pdf
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    Other versions of this item:

    • Laurent Germain & Fabrice Rousseau & Anne Vanhems, 2014. "Irrational Market Makers," Finance, Presses universitaires de Grenoble, vol. 35(1), pages 107-145.

    References listed on IDEAS

    as
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    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Marcin Czupryna, 2022. "Market makers activity: behavioural and agent based approach," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 30(1), pages 303-322, March.

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    More about this item

    Keywords

    Irrational Traders; Irrational Market makers; Overconfidence; Optimism.;
    All these keywords.

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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