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
Journal of Financial Economics (JFE), Forthcoming
We develop a model where some investors are uncertain whether others are trading on informative signals or noise. Uncertainty about others leads to a non-linear price that reacts asymmetrically to news. We incorporate this uncertainty into a dynamic setting where traders gradually learn about others and show that it generates 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: 63
Keywords: Learning, Asymmetric Information, Rational Expectations, Noise Trading, Sentiment, Difference of opinions, Volatility clustering, Leverage effect
JEL Classification: G12, G14
Date posted: September 2, 2012 ; Last revised: March 13, 2015
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