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A Theory of Noise Trading in Securities Markets
Author(s) -
TRUEMAN BRETT
Publication year - 1988
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1988.tb02590.x
Subject(s) - trading strategy , business , alternative trading system , investment (military) , noise (video) , high frequency trading , private information retrieval , algorithmic trading , private placement , incentive , investment management , investment banking , financial economics , finance , economics , microeconomics , computer science , computer security , artificial intelligence , politics , political science , law , image (mathematics)
In a recent article, Black [1] introduces a type of trading that he terms noise trading. He asserts that noise trading, which he defines as trading on noise as if it were information, must be a significant factor in securities markets. However, he does not provide an explanation of why any investors would rationally want to engage in noise trading. The goal of this paper is to provide such an explanation for one type of investor, managers of investment funds. As shown here, the incentive for a manager to engage in noise trading arises because of the positive signal that the level of the manager's trading provides about his or her ability to collect private information concerning current and potential investments. If the manager's compensation is directly related to investors' perceptions of his or her ability, the manager will then trade more frequently than is justified on the basis of his or her private information. In addition to providing this explanation for noise trading, the results of this analysis may also be useful for further empirical exploration of the relation between investment fund portfolio turnover and subsequent performance.