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Mathematics & Economics
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English (U.S.)
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Noise Traders and Stock Prices

Essay Instructions:

In this class we saw several models explaining why noise traders might potentially affect a company’s fundamental value. These models hinged on the implicit assumption that potential stakeholders look to a company’s stock price as an indicator of how profitable it would be for them to make a non-stock investment in the company. Do you think this is rational? If people know that noise traders exist, should that make a difference for the type of information they ascribe to the stock price?
Secondly, should corporate CEOs really care about the possibility that short-term stock price fluctuations might have long-term impacts on their companies? Or do you think it is more likely that CEOs care about stock price primarily because their own evaluation and compensation depends on it, and not because of any negative impacts it has on the company as a whole?

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Noise Traders and Stock Prices
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Noise Traders and Stock Prices
Noise traders buy and sell on their own beliefs of factors that, in reality, have no better returns than random choices. Their existence can either positively or negatively impact the market prices, depending on several factors (Collin, Pierre & Vyacheslav, 2019). This is the reason they are known to induce nice into market pricing. The market is more of a laboratory investigating noise traders' effect concerning market prices and stock price variations in either direction, both positively or negatively. Various publications were done on the effect of the noise traders at stock prices. Through real-world data on financial markets, there exists a complex interaction between noise trading and market efficiency in terms of stock prices. Security markets with more noise traders usually exhibit variance in prices (Aabo et al., 2017). The possible effect can be seen as the overpricing low probability events and underpricing high probability events. Therefore, in these terms, it is evident that the pricing patterns relate closely with the probability weighting functions developed by Kahneman and Tversky's in 1979. It is clear from various researches that the security markets where the noise traders are so limited, seem to perform efficiently without price variations. Usually, the highly liquid markets with unending noise traders portray an S-shape pattern due to mispricing. In most cases, noise traders are one time traders, but their impact on the market and stock prices are excellent.
An example is a surge in self-directed traders that happened in 2007 in the US. Trading reached unacceptable levels in the housing market that led to its crash in 2008 (Gao et al., 2018). Noise traders behave much of an irrational contrarian, meaning trading against price movements to their detriment. Their benefits consist the increasing the market volume and depth while reducing temporary impacts of price in markets.
Based on the below factors. CEOs of corporations should care about the possibility that short-term stock price fluctuations might have long t...
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