IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this article

Price discovery and sentiment

  • Jacoby, Gady
  • Liao, Rose C.
Registered author(s):

    This paper investigates the influence of sentimental noise traders on the security price adjustment. We use De Long et al.'s (1990) definition of noise traders, who falsely believe they have special information, to extend Easley and O'Hara's (1992) seminal model. Our extended model demonstrates the existence of noise traders in the market narrows bid-ask spreads and slows down the speed of price reversion to the fundamental value. Furthermore, the bid-ask spread widens when noise trader sentiment aligns with the market maker's prior beliefs. We show that the market maker's ability to accurately predict noise traders' sentiment is positively related to the quoted bid-ask spread and to the speed of price reversion. We demonstrate that Easley and O'Hara's model is a special case of our model. Their conclusion that time is a factor in the security price adjustment process is strengthened in the presence of the erroneous sentiment of noise traders.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://www.sciencedirect.com/science/article/pii/S105752191100086X
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

    Article provided by Elsevier in its journal International Review of Financial Analysis.

    Volume (Year): 21 (2012)
    Issue (Month): C ()
    Pages: 108-118

    as
    in new window

    Handle: RePEc:eee:finana:v:21:y:2012:i:c:p:108-118
    DOI: 10.1016/j.irfa.2011.09.005
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620166

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as in new window
    1. Malcolm Baker & Jeffrey Wurgler, 2004. "Investor Sentiment and the Cross-Section of Stock Returns," NBER Working Papers 10449, National Bureau of Economic Research, Inc.
    2. Lee, Wayne Y. & Jiang, Christine X. & Indro, Daniel C., 2002. "Stock market volatility, excess returns, and the role of investor sentiment," Journal of Banking & Finance, Elsevier, vol. 26(12), pages 2277-2299.
    3. Jegadeesh, Narasimhan & Titman, Sheridan, 1995. "Overreaction, Delayed Reaction, and Contrarian Profits," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 973-93.
    4. John C. Easterwood & Stacey R. Nutt, 1999. "Inefficiency in Analysts' Earnings Forecasts: Systematic Misreaction or Systematic Optimism?," Journal of Finance, American Finance Association, vol. 54(5), pages 1777-1797, October.
    5. Kent Daniel & David Hirshleifer & Avanidhar Subrahmanyam, 1998. "Investor Psychology and Security Market Under- and Overreactions," Journal of Finance, American Finance Association, vol. 53(6), pages 1839-1885, December.
    6. Chen, Jeng-Hong & Jiang, Christine X. & Kim, Jang-Chul & McInish, Thomas H., 2003. "Bid-Ask Spreads, Information Asymmetry, and Abnormal Investor Sentiment: Evidence from Closed-End Funds," Review of Quantitative Finance and Accounting, Springer, vol. 21(4), pages 303-21, December.
    7. 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.
    8. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    9. Easley, David, et al, 1996. " Liquidity, Information, and Infrequently Traded Stocks," Journal of Finance, American Finance Association, vol. 51(4), pages 1405-36, September.
    10. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
    11. Black, Fischer, 1986. " Noise," Journal of Finance, American Finance Association, vol. 41(3), pages 529-43, July.
    12. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, vol. 3(3), pages 205-258, August.
    13. Lee, Charles M C & Mucklow, Belinda & Ready, Mark J, 1993. "Spreads, Depths, and the Impact of Earnings Information: An Intraday Analysis," Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 345-74.
    14. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
    15. Chau, Frankie & Deesomsak, Rataporn & Lau, Marco C.K., 2011. "Investor sentiment and feedback trading: Evidence from the exchange-traded fund markets," International Review of Financial Analysis, Elsevier, vol. 20(5), pages 292-305.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:eee:finana:v:21:y:2012:i:c:p:108-118. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Shamier, Wendy)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.