Noise Traders, Market Sentiment, and Futures Price Behavior

OFOR-97-02

39 Pages Posted: 7 Nov 1997

See all articles by Dwight R. Sanders

Dwight R. Sanders

Southern Illinois University at Carbondale - Agribusiness Economics

Scott H. Irwin

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics

Raymond M. Leuthold

University of Illinois @ Urbana-Champaign

Date Written: May 1997

Abstract

The noise trader sentiment model of De Long, Shleifer, Summers, and Waldmann (1990a) is applied to futures markets. The theoretical results predict that overly optimistic (pessimistic) noise traders result in market prices that are greater (less) than fundamental value. Thus, returns can be predicted using the level of noise trader sentiment. The null rational expectations hypothesis is tested against the noise trader alternative using a commercial market sentiment index as a proxy for noise trader sentiment. Fama-MacBeth cross-sectional regressions test if noise traders create a systematic bias in futures prices. The time-series predictability of futures returns using known sentiment levels is tested in a Cumby-Modest market timing framework and a more general causality specification. The empirical results lead to the following conclusions. First, there is no evidence that noise trader sentiment creates a systematic bias in futures prices. Second, predictable market returns using noise trader sentiment is not characteristic of futures markets in general. Third, futures market returns at weekly intervals are characterized by low-order positive autocorrelation with relatively small autoregressive parameters. In those instances where there is evidence of noise trader effects, it is at best limited to isolated markets and particular specifications.

JEL Classification: G0, G1

Suggested Citation

Sanders, Dwight R. and Irwin, Scott H. and Leuthold, Raymond M., Noise Traders, Market Sentiment, and Futures Price Behavior (May 1997). OFOR-97-02. Available at SSRN: https://ssrn.com/abstract=39932 or http://dx.doi.org/10.2139/ssrn.39932

Dwight R. Sanders (Contact Author)

Southern Illinois University at Carbondale - Agribusiness Economics ( email )

Carbondale, IL 62901-4515
United States
618-453-1711 (Phone)

Scott H. Irwin

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics ( email )

1301 W. Gregory Drive
326 Mumford Hall, MC-710
Urbana, IL 61801
United States

Raymond M. Leuthold

University of Illinois @ Urbana-Champaign ( email )

1301 W. Gregory Drive
326 Mumford Hall
Urbana, IL 61801
United States
217-333-1810 (Phone)
217-333-5538 (Fax)

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