The Sound of Many Funds Rebalancing
59 Pages Posted: 16 Apr 2016 Last revised: 12 May 2020
Date Written: May 12, 2020
This paper proposes that computational complexity generates noise. The same asset is often held for completely different reasons by many funds following a wide variety of threshold-based trading rules. Under these conditions, we show it can be computationally infeasible to predict how these various trading rules will interact with one another, turning the net demand from these funds into unpredictable noise. This noise-generating mechanism can operate in a wide range of markets and also predicts how noise volatility will vary across assets. We confirm this prediction empirically using data on exchange-traded funds.
Keywords: Noise, Thresholds, Complexity, Indexing
JEL Classification: G00, G02, G14
Suggested Citation: Suggested Citation