Speculation and distribution of returns : a simulation and empirical study

The consequences of financial market speculation go far beyond the floors of stock and currency exchanges. In the last decade, speculative behaviour caused financial panics in South America, Southeast Asia and Russia. Questions about the reasons and nature of speculation once again attracted the attention of economists and financial practitioners. Although it seems to be rather impossible to provide a full explanation of speculation, partial evaluations are certainly possible.;This thesis concentrates on the impact of speculation on the distribution of market returns. The relationship between parameters of speculation processes and stable distribution is established. This allows conclusions to be drawn about the level of market speculation based on the estimated parameters of distribution of returns.;The thesis proposes an application of the minimum chi-squared methodology to estimate parameters of symmetric stable distribution. This approach offers substantial precision and flexibility when dealing with clustered, truncated and grouped data. It is applied to analyse Polish and Hungarian stock prices. In the main part of the thesis, the speculation processes that could produce heavy tailed returns are reviewed. The relationship between the parameters of the Diba-Grossman speculative process and those of the stable distribution of returns is evaluated. In particular, the positive dependence between the variance of the stochastic root of Diba-Grossman process and thickness of tails of the distribution is shown. In the empirical part, the thesis analyses returns to 66 stock indices. The tendency for mature markets to reveal slightly lower exposure to speculation than the emerging markets is found. Outlier tests show that some countries, e.g. Russia, Estonia and Bangladesh, are characterised by a lower level of speculation than is implied by the degrees of non-normality.