Risk seekers: trade, noise, and the rationalizing effect of market impact on convex preferences

Efstathios Avdis, - Apr 12, 2019

Long-held intuition dictates that information-based trade without exogenous noise is impossible. Risk seekers can resolve this conundrum. Not only do such traders undertake gambles that risk averters prefer to avoid, but they also inject enough noise into prices to obscure everyone's private information. Markets are therefore inefficient strictly due to noise in traders' endogenous signals. Moreover, risk seekers act as utility maximizers because, unlike noise traders, they fully internalize their impact on prices. This behavior also implies that economies with even a few risk seekers are empirically distinct from noise-trading models of inefficient markets.

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market design risk seeking Rationality inefficient markets information acquisition heterogeneity