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Dual Decision Processes and Noise Trading

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  • Francesco Cerigioni

Abstract

Evidence from financial markets suggests that asset prices can be consistently far from their fundamental value. Prices seem to underreact to news in the short-run and overreact in the long-run. In this paper, we use evidence from cognitive sciences to describe traders' behavior. A part of traders holds wrong beliefs anytime the market environment does not change sufficiently. We show that such model not only endogenizes noise trading while still allowing for rational one, but it also provides a justification for noise traders' beliefs and it shows that underreaction and overreaction naturally arise in such framework.

Suggested Citation

  • Francesco Cerigioni, 2016. "Dual Decision Processes and Noise Trading," Working Papers 925, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:925
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    References listed on IDEAS

    as
    1. Harrison Hong & Jeremy C. Stein, 1999. "A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets," Journal of Finance, American Finance Association, vol. 54(6), pages 2143-2184, December.
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    6. Barberis, Nicholas & Greenwood, Robin & Jin, Lawrence & Shleifer, Andrei, 2015. "X-CAPM: An extrapolative capital asset pricing model," Journal of Financial Economics, Elsevier, vol. 115(1), pages 1-24.
    7. Francesco Cerigioni, 2021. "Dual Decision Processes: Retrieving Preferences When Some Choices Are Automatic," Journal of Political Economy, University of Chicago Press, vol. 129(6), pages 1667-1704.
    8. Michael Kaestner, 2006. "Anomalous Price Behavior Following Earnings Surprises: Does Representativeness Cause Overreaction?," Finance, Presses universitaires de Grenoble, vol. 27(2), pages 5-31.
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    More about this item

    Keywords

    dual processes; noise trading; underreaction; overreaction; equity-premium;
    All these keywords.

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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