Speculation and Price Stability Under Uncertainty: A Generalization

Abstract

Since Friedman maintained that profitable speculation necessarily stabilizes prices, the necessary and sufficient conditions for his conjecture to hold have been derived following ex post analyses. However, within these frameworks, no uncertainty is involved. In this paper we assume the nonspeculative excess demand functions are always linear but with random slopes and intercepts (i. i. d. across time). Employing dynamic programming approaches, the optimal complete speculation sequence for a monopolistic speculator (which maximizes his long-run expected profits) can be characterized. Furthermore, Friedman's conjecture holds under this sequence. As for competitive speculation cases, we consider three variants arising from deviations of the monopolistic case. Of these, two models establish the property that Friedman's conjecture holds for optimal speculation sequences. However, since this conjecture might be falsified for the other model, a necessary condition is derived. Also, an example is given which shows that, if uncertainties are involved, a destabilizing optimal speculation sequence exists even with linear nonspeculative excess demand functions.

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