Noise Trading and Asset Pricing Factors
61 Pages Posted: 29 Apr 2019 Last revised: 20 Nov 2019
Date Written: November 18, 2019
We demonstrate that a large set of asset pricing factors (anomalies) are significantly exposed to “noise trader” risk, which arises from uninformative demand shifts of mutual fund investors. Mutual fund investors are largely ignorant of systematic factors and respond to simple signals when allocating capital to mutual funds. We measure the uninformed demand of factors by aggregating flow-induced trades of individual stocks underlying the factors. We find that mutual funds’ flow-induced trading significantly determines average returns, volatilities, and comovements among the well-studied factors, indicating that these factors are exposed to “noise trader” risk. Importantly, we show that this flow-driven “noise trader” risk is significantly priced by arbitrageurs and other investors.
Keywords: noise trader risk, factor premia, anomaly
JEL Classification: G10
Suggested Citation: Suggested Citation