The size and incidence of the losses from noise trading

Article Abstract:

Recent empirical research has identified a significant amount of volatility in stock prices that cannot easily be explained by changes in fundamentals; one interpretation is that asset prices respond not only to news but also to irrational "noise trading." We assess the welfare effects and incidence of such noise trading using an overlapping-generations model that gives investors short horizons. We find that the additional risk generated by noise trading can reduce the capital and consumption of the economy, and we show that part of that cost may be borne by rational investors. We conclude that the welfare costs of noise trading may be large if the magnitude of noise in aggregate stock prices is as large as suggested by some of the recent empirical literature on the excess volatility of the market. (Reprinted by permission of the publisher.)

Prices and rates, Stocks, Risk management, Capital assets, Stock prices

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Positive feedback investment strategies and destabilizing rational speculation

Article Abstract:

Analyses of rational speculation usually presumes that it dampens fluctuations caused by 'noise' traders. This is not necessarily the case if the noisy traders follow positive-feedback strategies - buy when prices rise and sell when prices fall. It may pay to jump on the bandwagon and purchase ahead of noise demand. If rational speculators' early buying triggers positive-feedback trading, then an increase in the number of forward-looking speculators can increase volatility about fundamentals. This model is consistent with a number of empirical observations about the correlation of asset returns, the overreaction of prices to news, prices bubbles, and expectations. (Reprinted by permission of the publisher.)

Analysis, Management, Speculation, Investments, Stock price forecasting, Floor traders (Finance)

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Good news for value stocks: further evidence on market efficiency

Article Abstract:

This article examines the hypothesis that the superior return to so-called value stocks is the result of expectational errors made by investors. We study stock price reactions around earnings announcements for value and glamour stocks over a 5-year period after portfolio formation. The announcement returns suggest that a significant portion of the return difference between value and glamour stocks is attributable to earnings surprises that are systematically more positive for value stocks. The evidence is inconsistent with a risk-based explanation for the return differential. (Reprinted by permission of the publisher.)

Efficient market theory

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