Noise Trading and Market Stability

31 Pages Posted: 8 Jul 2019

See all articles by Gao Xing

Gao Xing

University of Leicester

Daniel Ladley

University of Leicester - School of Business

Date Written: June 29, 2019

Abstract

Noise traders are often thought to be detrimental to market stability, increasing volatility and the risk of bubbles and crashes. The effect of noise traders on the learning and development of informed traders, however, has received little attention. We consider a computational model of a derivatives market containing informed traders and noise traders with the former group having to learn to price the traded asset. We demonstrate that noise traders have a beneficial effect on market stability: an increase in the amount of noise traders makes the market more resilient to shocks. Noise traders by pushing the price from fundamentals create opportunities for learning, increasing the proportion of informed traders possessing high levels of trading skills in turn protecting the market.

Keywords: Trading Skills, Learning, Heterogeneous Beliefs, Market Stability

JEL Classification: G10, G40, D83, C63

Suggested Citation

Xing, Gao and Ladley, Daniel, Noise Trading and Market Stability (June 29, 2019). Available at SSRN: https://ssrn.com/abstract=3415141 or http://dx.doi.org/10.2139/ssrn.3415141

Gao Xing

University of Leicester ( email )

University Road
Leicester, LE1 7RH
United Kingdom

Daniel Ladley (Contact Author)

University of Leicester - School of Business ( email )

University Road
Leicester, LE1 7RH
United Kingdom

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