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The Noise Trader Effect In A Walrasian Financial Market

Author

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  • Jukka Ilomäki

    (Faculty of Management, University of Tampere, Finland)

  • Hannu Laurila

    (Faculty of Management, University of Tampere, Finland)

Abstract

We assume rational risk averse informed investors who observe noisy information about the true value of a risky asset, rational risk averse uninformed investors who infer the true value from the price, and noise traders without any inferences. We have a static two period model where all trading happens in the first period. We show that, due to a negative shock caused by a random sentiment of noise traders, uninformed investors follow the noise because their risk increases. If there is a positive sentiment shock, uninformed investors bet against the noise. However, the equilibrium price stays at the fundamental value as long as the aggregate effect of informed investors is larger than that of noise traders. Thus, the risk premium adjusts perfectly in the market. This is consistent with the common finding of dynamic adjustment of the fundamental value with a time-varying risk premium.

Suggested Citation

  • Jukka Ilomäki & Hannu Laurila, 2018. "The Noise Trader Effect In A Walrasian Financial Market," Advances in Decision Sciences, Asia University, Taiwan, vol. 22(1), pages 405-419, December.
    • Handle: RePEc:aag:wpaper:v:22:y:2018:i:1:p:405-419
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    References listed on IDEAS

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    Cited by:

    1. Gianluca P. M. Virgilio & Manuel Ernesto Paz López, 2024. "Revisiting noise—Fischer Black’s noise at the time of high-frequency trading," Risk Management, Palgrave Macmillan, vol. 26(4), pages 1-22, December.
    2. Srilakshminarayana G, 2021. "Tail Behaviour of the Nifty-50 Stocks during Crises Periods," Advances in Decision Sciences, Asia University, Taiwan, vol. 25(4), pages 115-151, December.
    3. Chia-Lin Chang & Jukka Ilomäki & Hannu Laurila, 2021. "Leaning against the Bubble: Central Bank Intervention in Walrasian Asset Markets," Risks, MDPI, vol. 9(12), pages 1-12, December.

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    More about this item

    Keywords

    Risk aversion; informed investors; uninformed investors; sentiment shock; fundamental value;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G4 - Financial Economics - - Behavioral Finance

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