Noise Trading and Market Stability
31 Pages Posted: 8 Jul 2019
Date Written: June 29, 2019
Abstract
Noise traders are often thought to be detrimental to market stability, increasing volatility and the risk of bubbles and crashes. The effect of noise traders on the learning and development of informed traders, however, has received little attention. We consider a computational model of a derivatives market containing informed traders and noise traders with the former group having to learn to price the traded asset. We demonstrate that noise traders have a beneficial effect on market stability: an increase in the amount of noise traders makes the market more resilient to shocks. Noise traders by pushing the price from fundamentals create opportunities for learning, increasing the proportion of informed traders possessing high levels of trading skills in turn protecting the market.
Keywords: Trading Skills, Learning, Heterogeneous Beliefs, Market Stability
JEL Classification: G10, G40, D83, C63
Suggested Citation: Suggested Citation