Noise Momentum Around the World
38 Pages Posted: 13 Jul 2014
Date Written: July 11, 2014
We argue that arbitrageurs will strategically limit their initial investment in an arbitrage opportunity in anticipation of further mispricing caused by the deepening of noise traders’ misperceptions. Such ‘noise momentum’ is an important determinant of the overall arbitrage process. We design an empirical strategy to capture noise momentum in a two-period generalized error correction model (GECM). Applying it to a wide range of international spot-futures market pairs, we document pervasive evidence of noise momentum around the world.
Keywords: limited arbitrage, noise momentum, initial mispricing correction, futures and spot prices
JEL Classification: C12, C22, G13, G14
Suggested Citation: Suggested Citation