Signal or noise? Uncertainty and learning about whether other traders are informed

Snehal Banerjee and Brett Green

Journal of Financial Economics, 2015, vol. 117, issue 2, 398-423

Abstract: We develop a model where some investors are uncertain whether others are trading on informative signals or noise. Uncertainty about others leads to a nonlinear price that reacts asymmetrically to news. We incorporate this uncertainty into a dynamic setting where traders gradually learn about others and show that it generates empirically relevant return dynamics: expected returns are stochastic but predictable, and volatility exhibits clustering and the “leverage” effect. The model nests both the rational expectations (RE) and differences of opinions (DO) approaches and highlights a link between disagreement about fundamentals and uncertainty about other traders.

Keywords: Rational expectations; Difference of opinions; Sentiment; Volatility clustering; Leverage effect (search for similar items in EconPapers)
JEL-codes: D84 G12 G14 (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (35)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:117:y:2015:i:2:p:398-423

DOI: 10.1016/j.jfineco.2015.05.003

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