Listening to the Noise in Financial Markets

Lutz G. Arnold and David Russ

No 203, Working Papers from Bavarian Graduate Program in Economics (BGPE)

Abstract: Do all types of information benefit the efficiency of prices in the sense that they drive them closer to fundamentals compared to the situation where information does not exist? Looking at the competitive noisy rational expectations framework, the clear answer of the literature is: yes. It suggests that rational traders use all available types of information to submit more sophisticated market orders, thereby boosting price efficiency. In this paper, however, we propose a contradiction to this traditional view. We show that there exist types of non-fundamental information that are detrimental to price eciency, as they lead traders to rationally trade with rather than against noise. We develop an analytically tractable framework with public non-fundamental information and prove that this type of information can harm price efficiency, i.e., prices would be closer to fundamentals if public non-fundamental information did not exist.

Keywords: Rational Expectations Equilibrium; Market Eciency; Non-Fundamental Information; Destabilizing Rational Speculation. (search for similar items in EconPapers)
JEL-codes: C62 D53 G12 G40 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2020-12
New Economics Papers: this item is included in nep-cwa
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https://bgpe.cms.rrze.uni-erlangen.de/files/2023/0 ... inancial-Markets.pdf First version, 2020 (application/pdf)

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