40 Pages Posted: 4 Jun 2010 Last revised: 5 Jun 2010
Date Written: May 2010
We present a simple model in which rational but uninformed traders occasionally chase noise as if it were information, thereby amplifying sentiment shocks and moving prices away from fundamental values. We fill a theoretical gap in the literature by showing conditions under which noise traders can have an impact on market equilibrium disproportionate to their size in the market. The model offers a partial explanation for the surprisingly low market price of financial risk in the Spring of 2007.
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