Noise Trader Model of Agricultural Product Prices: Evidence from the Chinese Garlic Market

Abstract

This paper explores the determinants of the abnormal and volatile fluctuations of China’s agricultural product prices in recent years by examining the trading behavior of traders, especially that of irrational noise traders. We present an overlapping generations model of the garlic market in which noise traders with erroneous beliefs influence prices. Noise traders’ beliefs create a risk in the price of agricultural products that deters rational arbitrageurs from aggressively betting against them through changing supplies in a way that enables prices to diverge significantly from fundamental values even in the absence of fundamental risk. We also show that asymmetry of supply information, low price elasticity of demand, speculative capital inflows, restricted distribution channels, distorted wholesale markets from the perspective of market mechanisms and low risk aversion, biased self-attribution, and projection bias from the perspective of investor psychology, all influence expectations of investors and increase the volatility of agricultural product prices.