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Speculation is the practice of engaging in risky financial transactions in an attempt to profit from fluctuations in the market value of a tradable good such as a financial instrument, rather than attempting to profit from the underlying financial attributes embodied in the instrument such as capital gains, interest, or dividends. Many speculators pay little attention to the fundamental value of a security and instead focus purely on price movements. Speculation can in principle involve any tradable good or financial instrument. Speculators are particularly common in the markets for stocks, bonds, commodity futures, currencies, fine art, collectibles, real estate, and derivatives. Speculator Problems in Capital Market
Economic disadvantages
Auctions are a method of squeezing out speculators from a transaction, but they may have their own perverse effects by the winner’s curse. The winner’s curse, is, however, not very significant to markets with high liquidity for both buyers and sellers, as the auction for selling the product and the auction for buying the product occur simultaneously, and the two prices are separated only by a relatively small spread. That mechanism prevents the winner’s curse phenomenon from causing mispricing to any degree greater than the spread
Speculation is often associated with economic bubbles. A bubble occurs when the price for an asset exceeds its intrinsic value by a significant margin, although not all bubbles occur due to speculation. Speculative bubbles are characterized by rapid market expansion driven by word-of-mouth feedback loops, as initial rises in asset price attract new buyers and generate further inflation. The growth of the bubble is followed by a precipitous collapse fueled by the same phenomenon. Speculative bubbles are essentially social epidemics whose contagion is mediated by the structure of the market. Some economists link asset price movements within a bubble to fundamental economic factors such as cash flows and discount rates.
