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. The framework nests both rational expectations (RE) and differences of opinions (DO) models. However, it generates predictions that do not obtain in either. Specifically, 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 rich return dynamics: expected returns and volatility are stochastic but predictable, and volatility exhibits clustering.
Number of Pages in PDF File: 42
Keywords: Asset Prices, Learning, Asymmetric Information, Rational Expectations, Noise Trading, Sentiment
JEL Classification: G12, G14working papers series
Date posted: September 2, 2012 ; Last revised: April 10, 2014
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