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Neoclassical finance, behavioral finance and noise traders: A review and assessment of the literature

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  • Ramiah, Vikash
  • Xu, Xiaoming
  • Moosa, Imad A.

Abstract

While mainstream neoclassical finance ignores the role played by noise traders, a significant amount of empirical evidence is available to show that noise traders are active market participants and that their participation gives rise to market anomalies. Unlike neoclassical finance, behavioral finance allows for market inefficiency on the grounds that market participants are subject to common human errors that arise from heuristics and biases. In this paper we review the literature on the behavior of noise traders and analyze the consequences of their presence in the market, starting with a distinction between neoclassical finance and behavioral finance. We identify the market anomalies that provide evidence for the tendency of markets to trade at irrational levels, demonstrate how noise trading is related to some market fundamentals, and describe the models used to quantify noise trader risk.

Suggested Citation

  • Ramiah, Vikash & Xu, Xiaoming & Moosa, Imad A., 2015. "Neoclassical finance, behavioral finance and noise traders: A review and assessment of the literature," International Review of Financial Analysis, Elsevier, vol. 41(C), pages 89-100.
  • Handle: RePEc:eee:finana:v:41:y:2015:i:c:p:89-100
    DOI: 10.1016/j.irfa.2015.05.021
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    1. Brzeszczyński, Janusz & Gajdka, Jerzy & Kutan, Ali M., 2015. "Investor response to public news, sentiment and institutional trading in emerging markets: A review," International Review of Economics & Finance, Elsevier, vol. 40(C), pages 338-352.

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    Keywords

    Behavioral finance; EMH; Noise trader risk; Market anomalies;

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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