The economics of rational speculation in the presence of positive feedback trading

• We derive new results from a generalized version of De Long et al.'s pioneering model.
• Rational speculation can be stabilizing, e.g., in response to signals which arrive “early”.
• Any sort of short-term price response to a signal is possible, e.g., momentum or mean reversion.
• There is little scope for interpreting price movements are bubbles.

This paper generalizes De Long et al.'s (1990a) seminal model of destabilizing rational speculation in the presence of positive feedback trading by incorporating additional trading dates and an additional informative signal. Rational speculation can be stabilizing in the generalized model. The model is compatible with observed patterns of asset prices, such as short-term momentum and mean reversion. There is little scope for interpreting the equilibrium asset price as deviating from fundamental value.