Abstract
We develop a dynamic trading game in which fundamental insiders coexist with non-fundamental speculators. Non-fundamental speculators possess superior information about the future noise trades and are able to make sharper inference about the fundamental value with respect to the market maker. We show that non-fundamental speculators decrease market depth as well as the insider's ex-ante gains. We study inclusions in the S&P 500 after October 1989 as an example in which non-fundamental speculation may arise due to the preannouncement practice in index replacements. Evidence on the trading activity and the bid-ask spread pattern is consistent with our theoretical analysis.
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