A Closer Look at Short-Term Speculation on the Street: Evidence from A Residential Presale Market

Abstract

The role of short term speculation has been one central question in finance. It is often perceived that short term speculation is largely driven by uninformed investors who destabilize prices. However, empirical studies on the destabilizing effect of short term speculation are few and results are mixed. This paper empirically evaluates the role and performance of short term speculators by exploiting a unique data set in the residential presale market. The marketable forward ownership of properties in new residential developments allows cost-effective short term trading which facilitates direct identification of short term speculators. We find that short term speculation is driven by both feedback traders chasing short term price trends and informed arbitrageurs seeking underpriced assets. Both types of speculators outperform the market on average: momentum profits are mostly from market timing skills while informed traders are compensated by their superior project selection abilities. Informed speculators help improve pricing efficiency as their information gets impounded into prices over time. Momentum speculators trade on price signals and contribute to over-reaction and price reversals. We also study the impact of a change in taxation of short-term capital gains on speculation within our sample. Surprisingly, the increase in speculation costs deters only the informed traders instead of momentum traders. More importantly, the destabilizing effect due to momentum trading is only present when speculation costs are higher. Our results are consistent with Hong and Stein (1999) and, in particular, highlight the importance of information efficiency in understanding the destabilizing role of momentum traders. Furthermore, the findings in this paper raise doubts on the effectiveness of policies designed to deter short term trading and promote price stability by raising transaction costs.