The Price Impact and Survival of Irrational Traders
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4293-03.pdf
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Author(s)
Kogan, Leonid
Ross, Stephen
Wang, Jiang
Westerfield, Mark
Date Issued
March 21, 2003
Series/Report no.
MIT Sloan School of Management Working Paper;4293-03
Abstract
Milton Friedman argued that irrational traders will consistently lose money, won't
survive and, therefore, cannot influence long run equilibrium asset prices. Since his
work, survival and price influence have been assumed to be the same. Often partial
equilibrium analysis has been relied upon to examine the survival of irrational traders
and to make inferences on their influence on prices. In this paper, we demonstrate that
survival and influence on prices are two independent concepts. The price impact of
irrational traders does not rely on their long-run survival and they can have a significant
impact on asset prices even when their wealth becomes negligible. In addition, in
contrast to a partial equilibrium analysis, general equilibrium considerations matter
since the ability of irrational traders to impact prices even when their wealth is
diminishing can significantly affect their chances for long-run survival. In sum, in a
long-run equilibrium, we explicitly show that price impact can occur whether or not the
irrational traders survive. In related work, we show that even if the irrational traders
survive they may have no price impact.
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