Signal or Noise? Uncertainty and Learning about Whether Other Traders are Informed

63 Pages Posted: 2 Sep 2012 Last revised: 29 Mar 2017

See all articles by Snehal Banerjee

Snehal Banerjee

University of California, San Diego (UCSD) - Rady School of Management

Brett S. Green

Washington University in St. Louis - John M. Olin Business School

Date Written: January 1, 2015

Abstract

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.

Keywords: Learning, Asymmetric Information, Rational Expectations, Noise Trading, Sentiment, Difference of opinions, Volatility clustering, Leverage effect

JEL Classification: G12, G14

Suggested Citation

Banerjee, Snehal and Green, Brett S., Signal or Noise? Uncertainty and Learning about Whether Other Traders are Informed (January 1, 2015). Journal of Financial Economics (JFE), 2015, 117(2): 398-423. Available at SSRN: https://ssrn.com/abstract=2139771 or http://dx.doi.org/10.2139/ssrn.2139771

Snehal Banerjee (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

Brett S. Green

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

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