Abstract
This paper provides empirical evidence of the presence, proportion and trading behavior of noise traders in the U.S. equity market (S&P500 index). A simple methodology is used to estimate the heterogeneous agent asset pricing model involving noise traders’ risk, through GMM. Departing from previous estimations of heterogeneous agent models, it estimates fundamental price using the consumption-based asset pricing model and noise traders’ misperception as deviation from this price. It concludes that noise traders exist in the S&P500, they exaggerate price expectations as compared to fundamental traders, and traders (or investors) are rational, on average.
Highlights
1 Introduction Originating from the expected utility hypothesis of Von Neumann and Morgenstern (1953) and the mean-variance framework of Markowitz (1952) several standard asset pricing models have been developed, that assume the rationality of investors, such as capital asset pricing model (CAPM), arbitrage pricing theory (APT), three-factor and five-factor models by incorporating the factors which affect asset prices such as size, value, investment, and profitability
This paper contributes in favor of the presence and behavior of the noise traders by introducing a simple methodology to estimate heterogeneous agent models (HAMs) based on the fundamental value estimated through the standard representative agent model
To estimate the two models, S&P500 index monthly data is taken from January 1981 to June 2018, real per capita personal consumption data and monthly population is taken for the same period and frequency
Summary
Originating from the expected utility hypothesis of Von Neumann and Morgenstern (1953) and the mean-variance framework of Markowitz (1952) several standard asset pricing models have been developed, that assume the rationality of investors, such as capital asset pricing model (CAPM), arbitrage pricing theory (APT), three-factor and five-factor models by incorporating the factors which affect asset prices such as size, value, investment, and profitability. Assuming the deviation of noise traders’ expectations from the fundamental value of the asset, this model concludes that rational investors limit their willingness to take positions against noise traders misperception keeping that it may persist in the future This uncertainty in noise traders’ beliefs creates a risk in the market and affects asset prices. This paper contributes in favor of the presence and behavior of the noise traders by introducing a simple methodology to estimate HAMs based on the fundamental value estimated through the standard representative agent model.
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