Hostname: page-component-78c5997874-g7gxr Total loading time: 0 Render date: 2024-11-15T03:32:58.138Z Has data issue: false hasContentIssue false
  • English
  • Français

Do Noise Traders “Create Their Own Space?”

Published online by Cambridge University Press:  06 April 2009

Ravi Bhushan ,
David P. Brown  and
Antonio S. Mello
Ravi Bhushan
Affiliation:
Southern Methodist University
David P. Brown
Affiliation:
Finance Department, School of Business, Indiana University, Bloomington, IN 47405
Antonio S. Mello
Affiliation:
Finance Department, School of Business, University of Wisconsin-Madison, WI 53706
Get access Rights & Permissions [Opens in a new window]

Abstract

We analyze myopic trader models of noisy prices in financial markets. Unlike extant analysis, such as De Long et al. (1990a), a classical equilibrium exists in our analysis, e.g., a riskless perpetuity is priced by arbitrage and its price does not vary with noise. A unique noisy equilibrium exists only when i) noise traders' beliefs are rational regarding volatility and irrational regarding expected returns, and ii) noise traders can hold infinite positions. In the absence of these strong assumptions, multiple noisy equilibria can coexist with the classical equilibrium, but these equilibria exhibit conflicting comparative statics. Furthermore, the price of a long-lived asset with risky cash flows can vary with noise even when investors are not myopic. One conclusion is that myopia is neither a necessary nor a sufficient condition for noisy prices. A second is that it is difficult, if not impossible, to use myopic trader models to derive implications for investment or regulatory policy.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 32 , Issue 1 , March 1997 , pp. 25 - 45
Copyright
Copyright © School of Business Administration, University of Washington 1997

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Black, F. “Noise.” Journal of Finance, 41 (07 1986), 529–543.CrossRefGoogle Scholar
Breeden, D. T. “An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities.” Journal of Financial Economics, 7 (1979), 265–296.CrossRefGoogle Scholar
Campbell, J. Y., and Kyle, A. S.. “Smart Money, Noise Trading and Stock Price Behavior.” Review of Economic Studies, 60 (1993), 1–34.CrossRefGoogle Scholar
Cutler, D. M.; Poterba, J. M.; and Summers, L. H.. “Speculative Dynamics and the Role of Feedback Traders.” American Economic Review, 80 (1990), 63–68.Google Scholar
De Long, J. B.; Shleifer, A., Summers, L. H.; and Waldmann, R. J.. “The Size and Incidence of the Losses from Noise Trading.” Journal of Finance, 68 (1989), 681–696.CrossRefGoogle Scholar
De Long, J. B.; Shleifer, A., Summers, L. H.; and Waldmann, R. J.. “Noise Trader Risk in Financial Markets.” Journal of Political Economy, 98 (1990a), 703–738.CrossRefGoogle Scholar
De Long, J. B.; Shleifer, A., Summers, L. H.; and Waldmann, R. J.. “Positive Feedback Investment Strategies and Destabilizing Rational Speculation.” Journal of Finance, 45 (1990b), 379–395.CrossRefGoogle Scholar
Fama, E. F. “The Behavior of Stock Market Prices.” Journal of Business, 38 (1965), 34–105.CrossRefGoogle Scholar
French, K. R.; Schwert, G. W.; and Stambaugh, R. F.. “Expected Stock Returns and Volatility.” Journal of Financial Economics, 19 (1987), 3–29.CrossRefGoogle Scholar
Friedman, M. “The Case for Flexible Exchange Rates.” In Essays in Positive Economics. (Chicago, IL: Univ. of Chicago Press (1953).Google Scholar
Froot, K. A.; Scharfstein, D. S.; and Stein, J. C.. “Herd on the Street: Informational Inefficiencies in a Market with Short-Term Speculation.” Journal of Finance, 47 (1992), 1461–1484.Google Scholar
Grossman, S. J., and Miller, M.. “Liquidity and Market Structure.” Journal of Finance, 43 (1988), 617–633.CrossRefGoogle Scholar
Kyle, A. S. “Continuous Auctions and Insider Trading.” Econometrica, 53 (1985), 1315–1335.CrossRefGoogle Scholar
Malkiel, (1977).Google Scholar
Mehra, and Prescott, (1985).Google Scholar
Rubinstein, M. “The Valuation of Uncertain Income Streams and the Pricing of Options.” Bell Journal of Economics, 7 (1976), 407–425.CrossRefGoogle Scholar
Samuelson, P. A. “Proof that Properly Anticipated Prices Fluctuate Randomly.” Industrial Management Review, 6 (1965), 41–49.Google Scholar
Shleifer, A., and Vishny, R. W.. “Equilibrium Short Horizons of Investors and Firms.” American Economic Review, 80 (1990), 148–153.Google Scholar
Stein, J. C. “Rational Capital Budgeting in an Irrational World.” Working Paper No. 5496, National Bureau of Economic Research. Cambridge, MA (1996).CrossRefGoogle Scholar
Summers, L. H., and Summers, V P.. “When Financial Markets Work Too Well: A Cautious Case for a Securities Transaction Tax.” Journal of Financial Services Research, 3 (1989), 261–286.CrossRefGoogle Scholar
Umlauf, S. R. “Transaction Taxes and the Behavior of the Swedish Stock Market.” Journal of Financial Economics, 33 (1993), 227–240.CrossRefGoogle Scholar
Wang, J. “A Model of Intertemporal Asset Prices under Asymmetric Information.” Review of Economic Studies, 60 (1993), 249–282.CrossRefGoogle Scholar