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The Survival of Noise Traders in Financial Markets

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  • J. Bradford De Long
  • Andrei Shleifer
  • Lawrence H. Summers
  • Robert J. Waldmann,

Abstract

The authors present a model of portfolio allocation by noise traders with incorrect expectations about return variances. For such misperceptions, noise traders who do not affect prices can earn higher expected returns than rational investors with similar risk aversion. Moreover, such noise traders can come to dominate the market in that the probability that they eventually have a high share of total wealth is close to one. Noise traders come to dominate despite their taking of excessive risk and their higher consumption. The authors conclude that the case against their long-run viability is not as clear-cut as is commonly supposed. Coauthors are Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann. Copyright 1991 by University of Chicago Press.

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Paper provided by University of California at Berkeley, Economics Department in its series J. Bradford De Long's Working Papers with number _123.

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Handle: RePEc:wop:calbec:_123

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  1. John Y. Campbell & Albert S. Kyle, 1988. "Smart Money, Noise Trading and Stock Price Behavior," NBER Technical Working Papers 0071, National Bureau of Economic Research, Inc.
  2. 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.
  3. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  4. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 15(2), pages 457-510.
  5. Pagano, Marco, 1986. "Endogenous Market Thinness and Stock Price Volatility," CEPR Discussion Papers 146, C.E.P.R. Discussion Papers.
  6. Robert J. Shiller, 1984. "Stock Prices and Social Dynamics," Cowles Foundation Discussion Papers 719R, Cowles Foundation for Research in Economics, Yale University.
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