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Noise trading and informational efficiency

Chris H. Zhang and Bart Frijns

EconStor Preprints from ZBW - Leibniz Information Centre for Economics

Abstract: We investigate how noise trading affects informational efficiency of financial markets. Using full order book data from the Australian Securities Exchange, we find that noise trading harms informational efficiency. However, this is driven mainly by higher levels of noise trading, indicating that not all noise trading has the same effects. Further, behind the aggregate effects lies rich heterogeneity in how noise trading affects informational efficiency cross-sectionally. Noise trading harms informational efficiency of large liquid stocks but can be beneficial in small illiquid stocks, indicating that markets interpret noise trading differently. Finally, our results suggest that current regulation such as European-wide financial transaction tax (FTT) could have unintended effects on market quality. Instead, carefully designing a tax policy considering both firm-level characteristics and different levels of noise trading is more likely to be an optimal regulatory response.

Keywords: Market Microstructure; Noise trading; Informational efficiency; Regulation (search for similar items in EconPapers)
JEL-codes: G14 G18 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-mst
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:esprep:198037

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