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Failing to forecast real events

Journal

Journal of Financial Economics

Subject

Finance

Authors / Editors

Dow J;Bond P

Biographies

Publication Year

2021

Abstract

Do more talented traders prefer to bet on and against rare events or common events? Bets on rare events include out of the money options. Bets against rare events include the carry trade and investment grade bonds. In a model where traders specialize, equilibrium pricing reflects trading ability: A market with more skilled traders has a larger bid ask spread. We show that lower skill traders bet on and against rare events, while higher skill traders bet on and against frequent events, leading to higher bid-ask spreads in common event assets, and reducing financial markets’ ability to predict rare events.

Available on ECCH

No


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