noise traders in neo-classical economics vs behavioural economics Does neoclassical economics/finance exclude the existence of noise traders (as a contrast to rational traders)? Or do neoclassical models also sometimes accept the existence of noise traders?
The claim that financial markets are efficient is backed by an implicit argument that misinformed &quot;noise traders&quot; can have little influence on asset prices in equilibrium. If noise traders' beliefs are sufficiently different from those of rational agents to significantly affect prices, then noise traders will buy high and sell low. They will then lose money relative to rational investors and eventually be eliminated from the market. But De Long et al, 1987 (https://www.nber.org/papers/w2395) presented a simple overlapping-generations model of the stock market in which noise traders with erroneous and stochastic beliefs (a) significantly affect prices and (b) earn higher returns than do rational investors. Noise traders earn high returns because they bear a large amount of the market risk which the presence of noise traders creates in the assets that they hold: their presence raises expected returns because sophisticated investors dislike bearing the risk that noise traders may be irrationally pessimistic and push asset prices down in the future. The journal version of that paper is De Long, J. B., Shleifer, A., Summers, L. H., &amp; Waldmann, R. J. (1990). Noise trader risk in financial markets. Journal of political Economy, 98(4), 703-738.
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