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Noise trading and the management of operational risk; firms, traders and irrationality in financial markets

Willman, Paul, Fenton-O’Creevy, Mark, Nicholson, Nigel and Soane, Emma (2006) Noise trading and the management of operational risk; firms, traders and irrationality in financial markets. Journal of Management Studies, 43 (6). pp. 1357-1374. ISSN 1467-6486

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Abstract

Efficient market models cannot explain the high level of trading in financial markets in terms of asset portfolio adjustment. It is presumed that much of this excessive trading is irrational ‘noise’ trading. A corollary is that there must either be irrational traders in the market or rational traders with irrational aberrations. The paper reviews the various attempts to explain noise trading in the finance literature, concluding that the persistence of irrationality is not well explained. Data from a study of 118 traders in four large investment banks are presented to advance reasons why traders might seek to trade more frequently than financial models predict. The argument is advanced that trades do not simply occur in order to generate profit, but it does not follow that such trading is irrational. Trading may generate information, accelerate learning, create commitments and enhance social capital, all of which sustain traders’ long term survival in the market. The paper treats noise trading as a form of operational risk facing firms operating in financial markets and discusses approaches to the management of such risk.

Item Type: Article
Official URL: http://www3.interscience.wiley.com/journal/1179606...
Additional Information: © 2006 Blackwell Publishing Ltd
Library of Congress subject classification: H Social Sciences > HG Finance
H Social Sciences > HB Economic Theory
Sets: Departments > Management
Collections > Economists Online
Rights: http://www.lse.ac.uk/library/usingTheLibrary/academicSupport/OA/depositYourResearch.aspx
Date Deposited: 18 Nov 2009 16:58
URL: http://eprints.lse.ac.uk/25790/

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