Power of sophisticated investors
In his article “Price Momentum and Reversal: An Information Cascade Rationale “, Kaihua Deng examined investors’ sequential stock buying and selling behaviors and analyzed how rational investors’ perception of the market can influence the buildup of price momentum.
A basic rule of stock market is that while the first few buyers can comfortably hold the stock and see the price rise, late comers face a higher risk of buying into an asset that is being increasingly overvalued. Essentially, the cascading of information impounded in the past history of price changes becomes stronger to the degree that sophisticated investors are acting as guideposts for their followers. Risk-averse investors would modify their perception of the market state and exit the market in a timely manner.
The price momentum model Deng proposed shows that the exact timing of a reversal is stochastic and depends on the extent to which investors modify their reservation payoffs according to the past price movements. Price reversal eventually occurs in a later stage when stock price rises to above the expected payoffs.
The study combines Bayesian probability theory and information cascade we learned previously in order to model the influence of sophisticated investors on stock price reversal. Dangerous implications lie under the affirmation of their power because institutional investors could manipulate stock prices.
http://aeconf.com/Articles/Nov2016/aef170203.pdf