Noise Momentum Around the World
26 Pages Posted: 15 Mar 2018
Date Written: March 2018
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. Applying it to a wide range of international spot‐futures market pairs, we document pervasive evidence of noise momentum around the world.
Keywords: Futures and spot prices, Initial mispricing correction, Limited arbitrage, Noise momentum
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