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Chasing Noise

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  • Brock Mendel
  • Andrei Shleifer

Abstract

We present a simple model in which rational but uninformed traders occasionally chase noise as if it were information, thereby amplifying sentiment shocks and moving prices away from fundamental values. We fill a theoretical gap in the literature by showing conditions under which noise traders can have an impact on market equilibrium disproportionate to their size in the market. The model offers a partial explanation for the surprisingly low market price of financial risk in the Spring of 2007.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16042.

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Date of creation: May 2010
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Publication status: published as Mendel, Brock & Shleifer, Andrei, 2012. "Chasing noise," Journal of Financial Economics, Elsevier, vol. 104(2), pages 303-320.
Handle: RePEc:nbr:nberwo:16042

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  1. Barlevy, Gadi & Veronesi, Pietro, 2003. "Rational panics and stock market crashes," Journal of Economic Theory, Elsevier, Elsevier, vol. 110(2), pages 234-263, June.
  2. Jeremy C. Stein, 2009. "Presidential Address: Sophisticated Investors and Market Efficiency," Journal of Finance, American Finance Association, American Finance Association, vol. 64(4), pages 1517-1548, 08.
  3. Kogan, Leonid & Ross, Stephen & Wang, Jiang & Westerfield, Mark, 2003. "The Price Impact and Survival of Irrational Traders," Working papers, Massachusetts Institute of Technology (MIT), Sloan School of Management 4293-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  4. Stein, Jeremy C, 1987. "Informational Externalities and Welfare-Reducing Speculation," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 95(6), pages 1123-45, December.
  5. De Long, J. Bradford & Shleifer, Andrei & Summers, Lawrence H. & Waldmann, Robert J., 1990. "Noise Trader Risk in Financial Markets," Scholarly Articles 3725552, Harvard University Department of Economics.
  6. Franklin Allen & Stephen Morris & Hyun Song Shin, 2006. "Beauty Contests and Iterated Expectations in Asset Markets," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 19(3), pages 719-752.
  7. Bikhchandani, Sushil & Hirshleifer, David & Welch, Ivo, 1992. "A Theory of Fads, Fashion, Custom, and Cultural Change in Informational Cascades," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 100(5), pages 992-1026, October.
  8. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, Econometric Society, vol. 53(6), pages 1315-35, November.
  9. George-Marios Angeletos & Alessandro Pavan, 2007. "Policy with Dispersed Information," NBER Working Papers 13590, National Bureau of Economic Research, Inc.
  10. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, American Finance Association, vol. 45(2), pages 379-95, June.
  11. Thomas M. Mertens & Tarek A. Hassan, 2010. "The Social Cost of Near-Rational Investment," 2010 Meeting Papers, Society for Economic Dynamics 370, Society for Economic Dynamics.
  12. Wang, Jiang, 1993. "A Model of Intertemporal Asset Prices under Asymmetric Information," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 60(2), pages 249-82, April.
  13. Allen, Franklin & Gale, Douglas, 1992. "Stock-Price Manipulation," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 5(3), pages 503-29.
  14. George-Marios Angeletos & Jennifer La'O, 2009. "Incomplete Information, Higher-Order Beliefs and Price Inertia," NBER Working Papers 15003, National Bureau of Economic Research, Inc.
  15. Grossman, Sanford J & Stiglitz, Joseph E, 1976. "Information and Competitive Price Systems," American Economic Review, American Economic Association, American Economic Association, vol. 66(2), pages 246-53, May.
  16. Froot, Kenneth A & Scharftstein, David S & Stein, Jeremy C, 1992. " Herd on the Street: Informational Inefficiencies in a Market with Short-Term Speculation," Journal of Finance, American Finance Association, American Finance Association, vol. 47(4), pages 1461-84, September.
  17. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
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Cited by:
  1. Robert S. Chirinko & Christopher Curran, 2013. "Greenspan Shrugs: Central Bank Communication, Formal Pronouncements and Bond Market Volatility," CESifo Working Paper Series 4236, CESifo Group Munich.
  2. Buckley, Winston & Long, Hongwei & Perera, Sandun, 2014. "A jump model for fads in asset prices under asymmetric information," European Journal of Operational Research, Elsevier, Elsevier, vol. 236(1), pages 200-208.
  3. Yang, Chunpeng & Li, Jinfang, 2013. "Investor sentiment, information and asset pricing model," Economic Modelling, Elsevier, Elsevier, vol. 35(C), pages 436-442.
  4. Weihong HUANG & Wanying Wang, 2012. "Price-Volume Relations in Financial Market," Economic Growth centre Working Paper Series, Nanyang Technolgical University, School of Humanities and Social Sciences, Economic Growth centre 1209, Nanyang Technolgical University, School of Humanities and Social Sciences, Economic Growth centre.
  5. Yang, Chunpeng & Li, Jinfang, 2014. "Two-period trading sentiment asset pricing model with information," Economic Modelling, Elsevier, Elsevier, vol. 36(C), pages 1-7.

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