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The Contribution of Speculators to Effective Financial Markets

Catalyst Monograph Series, 1995

Geert Bekaert
Stanford University, Stanford, California, USA 94305
National Bureau of Economic Research, Cambridge, Massachusetts, USA 02138

Márcio G. P. Garcia
Pontifical Catholic University, Rio de Janeiro, Brazil
National Council for Scientific and Technical Development (CNPq)

Campbell R. Harvey
Duke University, Durham, North Carolina, USA 27708
National Bureau of Economic Research, Cambridge, Massachusetts, USA 02138

We present critical examination of the role of the speculator in transitional market-based economies. Speculators provide additional liquidity to the market and, in general, enhance the operational efficiency of the market. This serves to reduce the cost of capital which has broad positive implications for the welfare of the whole society. However, we argue that the presense of speculators alone does not guarantee these benefits. Indeed, the presense of a small group of speculators may lead to a disortion of market prices. Hence, in order to ensure the positive benefits, there must exist a sufficient number of speculators -- both domestic and international. Our policy recommendations focus on ways to obtain this critical mass.