The more myopic, the more chaos? How the degree of traders’ short-termism affects the financial market equilibrium

We investigate the impact of the extent of investors’ short-termism on the market equilibrium in a dynamic rational expectations model. We show that multiple equilibria always arise irrespective of the degree of traders’ myopia, and that short-termism alone may not be the cause of equilibrium multiplicity, but it does significantly affect the market quality of all equilibria. The liquidity, price efficiency and expected trading volume under the high trading intensity equilibrium (HTIE) are higher than those under the low trading intensity equilibrium (LTIE) no matter how myopic the informed traders are. As the extent of investors’ short-termism increases, the difference between the HTIE and LTIE becomes larger. Interestingly, an increase in the degree of investors’ myopia in the market on the one hand mitigates the instability of the unstable equilibrium --- the HTIE (upon market perturbations a higher degree of investors’ myopia slows down the deviation from the original equilibrium under an HTIE), but on the other hand also dampens the stability of the stable equilibrium --- the LTIE (upon market perturbations a higher degree of investors’ myopia slows down the converging process to the original equilibrium under an LTIE).