Institut d'Anàlisi Econòmica, CSIC, and Center for Economic Research, Tilburg University. I would like to thank Alan Kirman, Matthew Rabin, József Sákovics, Andrei Shleifer, Xavier Vives, Robert Waldmann, an anonymous referee, and participants in seminars at Bank of England, Louvain-la-Neuve, and ECARE for helpful comments on earlier versions of this article. The usual disclaimer applies.
Noise Trading in Small Markets
Article first published online: 30 APR 2012
1996 The American Finance Association
The Journal of Finance
Volume 51, Issue 4, pages 1537–1550, September 1996
How to Cite
PALOMINO, F. (1996), Noise Trading in Small Markets. The Journal of Finance, 51: 1537–1550. doi: 10.1111/j.1540-6261.1996.tb04079.x
- Issue published online: 30 APR 2012
- Article first published online: 30 APR 2012
Considering noise traders as agents with unpredictable beliefs, we show that in an imperfectly competitive market with risk averse investors, noise traders may earn higher expected utility than rational investors. This happens when, by deviating from the Nash equilibrium strategy, noise traders hurt rational investors more than themselves. It follows that the willingness of arbitrageurs to exploit noise traders' misperceptions is lower relative to a perfectly competitive economy. This result reinforces the theory that noise trading may explain closed-end fund discounts and small firms' returns, since these markets are less competitive than the market for large firms' stock.