Suppose you think that most traders in the market are rational, self-interested, and risk neutral, but some fraction (say 30-50%) of participants in the market are “feedback traders.” Feedback traders will follow the following trading rule: If the price change (in percent) between round t-1 and t was b%, in round t+1 these participants will buy at prices below (1+b)pt, and sell above that price.
a. What pattern do you think prices will follow?
b. Describe a strategy for trading against the mix of rational and feedback traders, and explain why you think it will work.