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Chasing noise

  • Mendel, Brock
  • Shleifer, Andrei

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. In the model, 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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File URL: http://www.sciencedirect.com/science/article/pii/S0304405X11000511
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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 104 (2012)
Issue (Month): 2 ()
Pages: 303-320

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Handle: RePEc:eee:jfinec:v:104:y:2012:i:2:p:303-320
DOI: 10.1016/j.jfineco.2011.02.018
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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  1. 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, vol. 100(5), pages 992-1026, October.
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  7. Grossman, Sanford J & Stiglitz, Joseph E, 1976. "Information and Competitive Price Systems," American Economic Review, American Economic Association, vol. 66(2), pages 246-53, May.
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  9. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
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  14. Kogan, Leonid & Ross, Stephen & Wang, Jiang & Westerfield, Mark, 2003. "The Price Impact and Survival of Irrational Traders," Working papers 4293-03, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  15. Franklin Allen & Stephen Morris & Hyun Song Shin, 2006. "Beauty Contests and Iterated Expectations in Asset Markets," Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 719-752.
  16. Jiang Wang, 1993. "A Model of Intertemporal Asset Prices Under Asymmetric Information," Review of Economic Studies, Oxford University Press, vol. 60(2), pages 249-282.
  17. Stein, Jeremy C., 1987. "Informational Externalities and Welfare-Reducing Speculation," Scholarly Articles 3660740, Harvard University Department of Economics.
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