37 Pages Posted: 6 Sep 2017
Date Written: September 2017
We introduce imperfect information in stock prices determination. Agents, whose expectations are not assumed to be rational, receive a noisy signal about the structural shock driving future dividend variations. Equilibrium stock prices are decomposed into a fundamental component and a transitory ‘noise bubble’ which can be responsible for boom and bust episodes unrelated to economic fundamentals. We propose a non‐standard VAR procedure to estimate the effects of noise shocks as well as bubble episodes. Noise explains a large fraction of US stock prices. In particular the dot‐com bubble is almost entirely explained by noise.
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