SPECULATION AND PRICE FLUCTUATIONS WITH PRIVATE, EXTRINSIC SIGNALS

We consider an overlapping generations model in which asset prices are determined through a Vickrey auction. The existence of speculative (sunspot) equilibria is proven, where traders strictly prefer to act based on private, nonfundamental signals. An example is presented in which speculation over "market psychology" nearly drives fundamental analysis (inside information about dividends) out of the market. Another example demonstrates price fluctuations that persist as the number of traders approaches infinity. The equilibria produce price fluctuations without any trader able to identify the source; we informally argue that the model sheds light on the phenomenon of technical analysis. © 1991.