Prof. Jayant R. Verma’s recent posting makes a provocative case in support of day traders, noise traders, speculators, hoarders, flashers, scalpers and what have you.
It has been accepted wisdom for some time now that speculators are beneficial to markets in providing liquidity and facilitating price discovery. For Prof. Varma the benefits don’t stop there. He claims that by generating volatility, speculators actually reduce the “tail risk,” big and totally unexpected movements in prices that have come to precede (and possibly cause) financial crises of various kinds. By keeping investors on their toes, this speculation-generated volatility helps guard against the sort of unthinking complacency that characterized the real estate boom.
The Indian experience, at least so far as stock markets are concerned, seems to bear this out. Most small cap stocks that find themselves in the 5% circuit limit category actually exhibit more volatility over the medium term when compared to their brethren in the 10% circuit limit category. The argument that the volatility in these stocks would actually be higher were it not for the tighter circuit limits is, unfortunately, un-falsifiable and likely to persist despite reasons and indications to the contrary.
If we were to accept the thesis that active speculation is necessary not just for liquidity, but also for market stability then one could argue that, other things being equal, public policy should support speculative activity instead of hindering, much less inhibiting, it. Prof. Varma’s suggestion of a “Tobin Subsidy” is not really one; He proposes merely that real-estate speculators be allowed to get a refund on stamp duties paid when “flipping” property making it more of a “Tobin Tab-break.” Nevertheless, I’m sure all this talk has old man Tobin spinning in his grave.
