Noise Trading and Informational Efficiency

42 Pages Posted: 14 Jun 2019 Last revised: 16 Jun 2019

See all articles by Chris H Zhang

Chris H Zhang

Auckland University of Technology - Department of Finance

Bart Frijns

Auckland University of Technology - Faculty of Business & Law

Date Written: May 30, 2019

Abstract

We investigate how noise trading affects informational efficiency of financial markets. Using full order book data from the Australian Securities Exchange, we find that noise trading harms informational efficiency. However, this is driven mainly by higher levels of noise trading, indicating that not all noise trading has the same effects. Further, behind the aggregate effects lies rich heterogeneity in how noise trading affects informational efficiency cross-sectionally. Noise trading harms informational efficiency of large liquid stocks but can be beneficial in small illiquid stocks, indicating that markets interpret noise trading differently. Finally, our results suggest that current regulation such as European-wide financial transaction tax (FTT) could have unintended effects on market quality. Instead, carefully designing a tax policy considering both firm-level characteristics and different levels of noise trading is more likely to be an optimal regulatory response.

Keywords: Market microstructure; Noise trading; Informational efficiency; Regulation

JEL Classification: G14; G18

Suggested Citation

Zhang, Chris H and Frijns, Bart, Noise Trading and Informational Efficiency (May 30, 2019). Available at SSRN: https://ssrn.com/abstract=3397979 or http://dx.doi.org/10.2139/ssrn.3397979

Chris H Zhang (Contact Author)

Auckland University of Technology - Department of Finance ( email )

Auckland, 1142
New Zealand

Bart Frijns

Auckland University of Technology - Faculty of Business & Law ( email )

3 Wakefield Street
Private Bag 92006
Auckland Central 1020
New Zealand

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