Noise Trader Risk in Financial Markets

Abstract

The authors present a simple overlapping generations model of an asset market in which irrational noise traders with erroneous stochastic beliefs both affect prices and earn higher expected returns. The unpredictability of noise traders' beliefs creates a risk in the price of the asset that deters rational arbitrageurs from aggressively betting against them. As a result, prices can diverge significantly from fundamental values even in the absence of fundamental risk. Moreover, bearing a disproportionate amount of risk that they themselves create enables noise traders to earn a higher expected return than rational investors do. The model sheds light on a number of financial anomalies. Copyright 1990 by University of Chicago Press.

Keywords

Limits to arbitrageEconomicsArbitrageMean reversionStock (firearms)Financial economicsEquity (law)Capital asset pricing modelFinancial marketVolatility (finance)Asset (computer security)Rational expectationsIrrational numberRisk premiumMonetary economicsEconometricsFinance

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Publication Info

Year: 1990
Type: article
Volume: 98
Issue: 4
Pages: 703-738
Citations: 6228
Access: Closed

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APA Style

                            
                                
                                    J. Bradford De Long, 
                                
                                    Andrei Shleifer, 
                                
                                    Lawrence H. Summers
                                
                                et al.
                            
                            (1990). 
                            Noise Trader Risk in Financial Markets. 
                            Journal of Political Economy
                            , 98
                            (4)
                            , 703-738.
                            https://doi.org/10.1086/261703
                        

Identifiers

DOI: 10.1086/261703