Dual Decision Processes and Noise Trading

Francesco Cerigioni

No 925, Working Papers from Barcelona School of Economics

Abstract: Evidence from financial markets suggests that asset prices can be consistently far from their fundamental value. Prices seem to underreact to news in the short-run and overreact in the long-run. In this paper, we use evidence from cognitive sciences to describe traders' behavior. A part of traders holds wrong beliefs anytime the market environment does not change sufficiently. We show that such model not only endogenizes noise trading while still allowing for rational one, but it also provides a justification for noise traders' beliefs and it shows that underreaction and overreaction naturally arise in such framework.

Keywords: underreaction; dual processes; noise trading; overreaction; equity-premium (search for similar items in EconPapers)
JEL-codes: G02 G11 G12 (search for similar items in EconPapers)
Date: 2016-09
New Economics Papers: this item is included in nep-mst and nep-upt
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Working Paper: Dual decision processes and noise trading (2016)
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