Signal or Noise? Uncertainty and Learning about Whether Other Traders are Informed
Kellogg School of Management - Department of Finance
Brett S. Green
University of California, Berkeley - Haas School of Business
We develop a model in which some traders are uncertain whether other market participants are trading on informative signals or noise. Uncertainty about other investors generates a non-linear price that reacts asymmetrically to news. In fact, the price may even decrease with additional good news. We incorporate this uncertainty into a dynamic setting where traders gradually learn about others, which leads to empirically relevant return dynamics: expected returns are stochastic but predictable, and volatility exhibits clustering and the “leverage” effect. The model nests both the rational expectations (RE) and differences of opinions (DO) approaches and highlights a link between disagreement about fundamentals and uncertainty about other traders.
Number of Pages in PDF File: 51
Keywords: Asset Prices, Learning, Asymmetric Information, Rational Expectations, Noise Trading, Sentiment
JEL Classification: G12, G14working papers series
Date posted: September 2, 2012 ; Last revised: June 18, 2014
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