The Size and Incidence of the Losses from Noise Trading

24 Pages Posted: 16 Jul 2004

See all articles by J. Bradford DeLong

J. Bradford DeLong

University of California, Berkeley; Federal Reserve Bank of San Francisco; National Bureau of Economic Research (NBER)

Andrei Shleifer

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Lawrence H. Summers

Harvard University; National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Robert Waldmann

Universita di Roma Tor Vergata; National Bureau of Economic Research (NBER)

Date Written: March 1989

Abstract

Recent empirical research has identified a significant amount of volatility in stock prices that cannot be easily explained by changes in fundamentals; one interpretation is that asset prices respond not only to news but also to irrational "noise trading." We assess the welfare effects and incidence of such noise trading using an overlapping-generations model that gives investors short horizons. We find that the additional risk generated by noise trading can reduce the capital stock and consumption of the economy, and we show that part of that cost may be borne by rational investors. We conclude that the welfare costs of noise trading may be large if the magnitude of noise in aggregate stock prices is as large as suggested by some of the recent empirical literature on the excess volatility of the market.

Suggested Citation

DeLong, James Bradford and Shleifer, Andrei and Summers, Lawrence H. and Waldmann, Robert, The Size and Incidence of the Losses from Noise Trading (March 1989). NBER Working Paper No. w2875. Available at SSRN: https://ssrn.com/abstract=457562

James Bradford DeLong (Contact Author)

University of California, Berkeley ( email )

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Andrei Shleifer

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Lawrence H. Summers

Harvard University ( email )

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Robert Waldmann

Universita di Roma Tor Vergata ( email )

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