Smart Money, Noise Trading And Stock Price Behavior
This paper estimates an equilibrium model of stock price behavior in which changes in exponentially detrended dividends and prices are normally distributed and exogenous "noise traders" interact with "smart-money" investors who have constant absolute ris k aversion. The model can explain the volatility and predictability of U.S. stock returns in the period 1871-1986 using either a low discount rate (4 percent or below) and a large constant risk discount on the stock price, or a higher discount rate (5 percent or above) and noise trading correlated with fundamentals. The data are not well able to distinguish between these explanations. Copyright 1993 by The Review of Economic Studies Limited.
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