Manipulating market sentiment

- We analyze the interaction between a large rational trader and naïve speculators.
- Naïfs trade after a streak of price deviations from the asset's fundamental value.
- Naifs' trading rule does not follow a trend or respond to price trends.
- Nevertheless, the model gives rise to rich patterns of price fluctuations.
- The model synthesizes opposing views regarding the role of rational speculators.

We analyze a simple model of an asset market, in which a large rational trader interacts with “noise speculators” who seek short-run speculative gains, and become active following a prolonged episode of mispricing relative to the asset's fundamental value. The model gives rise to price patterns such as bubble dynamics, positive short-run correlation and vanishing long-run correlation of price deviations from the fundamental value. We argue that this example model sheds light on the question as to whether rational speculators abet or curb price fluctuations.