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Signal or noise? Uncertainty and learning about whether other traders are informed

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  • Banerjee, Snehal
  • Green, Brett

Abstract

We develop a model where some investors are uncertain whether others are trading on informative signals or noise. Uncertainty about others leads to a nonlinear price that reacts asymmetrically to news. We incorporate this uncertainty into a dynamic setting where traders gradually learn about others and show that it generates empirically relevant return dynamics: expected returns are stochastic but predictable, and volatility exhibits clustering and the “leverage” effect. The model nests both the rational expectations (RE) and differences of opinions (DO) approaches and highlights a link between disagreement about fundamentals and uncertainty about other traders.

Suggested Citation

  • Banerjee, Snehal & Green, Brett, 2015. "Signal or noise? Uncertainty and learning about whether other traders are informed," Journal of Financial Economics, Elsevier, vol. 117(2), pages 398-423.
  • Handle: RePEc:eee:jfinec:v:117:y:2015:i:2:p:398-423
    DOI: 10.1016/j.jfineco.2015.05.003
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    More about this item

    Keywords

    Rational expectations; Difference of opinions; Sentiment; Volatility clustering; Leverage effect;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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