See

discussions, stats, and author profiles for this publication at: https://www.researchgate.net/publication/278333406

Neoclassical Finance, Behavioural Finance and

Noise Traders: A Review and Assessment of the
Literature

Article in International Review of Financial Analysis · June 2015

DOI: 10.1016/j.irfa.2015.05.021

CITATIONS READS

4 567

3 authors, including:

Vikash Ramiah Imad Moosa

University of South Australia RMIT University
65 PUBLICATIONS 152 CITATIONS 357 PUBLICATIONS 2,504 CITATIONS

SEE PROFILE SEE PROFILE

Some of the authors of this publication are also working on these related projects:

Econometrics as a Con Art View project

Bitcoin View project

All content following this page was uploaded by Imad Moosa on 30 January 2016.

The user has requested enhancement of the downloaded file.

 International Review of Financial Analysis 41 (2015) 89–100

Contents lists available at ScienceDirect

International Review of Financial Analysis

Review

Neoclassical finance, behavioral finance and noise traders: A review and

assessment of the literature☆
Vikash Ramiah a,⁎, Xiaoming Xu b, Imad A. Moosa c
a
School of Commerce, University of South Australia, 37-44 North Terrace, Adelaide, South Australia, 5000, Australia
b
Beijing Technology and Business University, Lab Center of Business and Law, Liang-Xiang-Gao-Jiao-Yuan-Qu, Fang-Shan Dist, Beijing, P.R. China, 102488
c
School of Economics, Finance and Marketing, RMIT University, 445 Swanston Street, Melbourne, Victoria, 3000, Australia

a r t i c l e i n f o a b s t r a c t

Article history: While mainstream neoclassical finance ignores the role played by noise traders, a significant amount of empirical
Received 4 February 2015 evidence is available to show that noise traders are active market participants and that their participation gives
Received in revised form 4 May 2015 rise to market anomalies. Unlike neoclassical finance, behavioral finance allows for market inefficiency on the
Accepted 31 May 2015
grounds that market participants are subject to common human errors that arise from heuristics and biases. In
Available online 4 June 2015
this paper we review the literature on the behavior of noise traders and analyze the consequences of their presence
JEL classification:
in the market, starting with a distinction between neoclassical finance and behavioral finance. We identify the
G1 market anomalies that provide evidence for the tendency of markets to trade at irrational levels, demonstrate
G11 how noise trading is related to some market fundamentals, and describe the models used to quantify noise trader
risk.
Keywords: © 2015 Elsevier Inc. All rights reserved.
Behavioral finance
EMH
Noise trader risk
Market anomalies

Contents

1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
2. Neoclassical finance versus behavioral finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
3. Market anomalies and evidence for irrational behavior . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
3.1. Momentum profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
3.2. Contrarian profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
3.3. Overreaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
3.4. Underreaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93
3.5. Information pricing errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
3.6. Technical analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
4. Noise trading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
5. Noise trading and fundamentals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
5.1. Volume . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
5.2. Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
5.3. Firm size . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
5.4. Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
5.5. Capital expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
5.6. Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
6. Quantifying noise trader risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97
7. Conclusions and future remarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98
References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

☆ We would like to thank the editor of this journal and an anonymous referee for useful comments. We are grateful to Afaf Moosa for drawing Fig. 1 and Petko Kalev for his help with
the revision of the paper.
⁎ Corresponding author at: UNISA.

http://dx.doi.org/10.1016/j.irfa.2015.05.021
1057-5219/© 2015 Elsevier Inc. All rights reserved.
90 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100

1. Introduction in the early 1950s when Markowitz (1952) introduced portfolio optimi-
zation theory. That was followed by Modigliani and Miller (1958, 1963)
A “noise trader” is a term that is used to describe a market participant who put forward the capital structure irrelevance theorem. Sharpe
who makes investment decisions without the use of finance fundamen- (1964) and Lintner (1965) developed asset pricing models, including
tals, exhibits poor market timing, follows trends and tends to overreact the CAPM whereas Fama (1965, 1970) set out the conditions for various
or underreact to good and bad news. For instance, Black (1986) describes forms of market efficiency and put forward the efficient market
noise traders as investors who do not trade on the basis of information hypothesis. In the 1970s Black and Scholes (1973) pioneered option-
while Bender, Osler, and Simon (2013) find evidence indicating that pricing theory. In the 1990s, Fama and French (1993, 1996) created a
noise traders use technical analysis in the form of the “head-and- “thriving industry” out of their three-factor model, and since then no
shoulders” chart pattern. Lee, Shleifer, and Thaler (1991) demonstrate less than 50 factors have been tried in various modifications of the
that noise traders are active and that they do influence market prices. three-factor model (Subrahmanyam, 2010).
In terms of rationality, traders may be classified into information users In short, neoclassical finance tells us the following: (i) the market
(rational or information traders) and irrational (noise) traders. value of an asset should be aligned with its fundamental value;
Yet mainstream neoclassical finance does not recognize noise (ii) financial markets react quickly to new information; (iii) prices
traders, ignoring them on the grounds that their role is trivial. The follow a random walk process resulting from the random arrival of infor-
main pillar of neoclassical finance, the efficient market hypothesis mation; and (iv) no investor can consistently earn abnormal return in ex-
(EMH), postulates that financial asset prices reflect all available informa- cess of what is consistent with risk. While the contribution of neoclassical
tion because market participants are rational processors of information. finance is unquestionable, the doctrine has failed to provide valid expla-
Prior to the 1980s not much attention was paid to noise traders and nations for the persistence of market anomalies. Furthermore, the main
other forms of irrational behavior, but the observation of market pillars of neoclassical finance (the efficient market hypothesis and
anomalies changed that as the proponents of behavioral finance posed CAPM) have come under severe criticism since the global financial crisis
a challenge to the EMH. A significant amount of empirical evidence is (for a survey of the views for and against, see Moosa, 2013; Moosa &
available to show that noise traders are involved in liquidity trading
(Dow & Gorton, 1993; Foster & Viswanathan, 1990, 1993; Pagano &
Table 1
Roell, 1996), hedging (Dow & Gorton, 1994) and speculation (De Long, Timeline of research evolution in neoclassical finance.
Shleifer, Summers, & Waldman, 1990). The behavioral finance school
Author(s) Issue(s) Findings/Conclusions
of thought allows for market inefficiency on the grounds that market
participants are subject to common human errors that arise from Markowitz Portfolio The first stage of portfolio selection
heuristics and biases. (1952) selection involves the formation of relevant beliefs
on the basis of observation. The second
In this paper we review the literature on the behavior of noise stage starts with the relevant beliefs and
traders and analyze the consequences of their presence in the market. ends with the selection of a portfolio.
We start with a distinction between the mainstream neoclassical Modigliani and Capital structure Laying the foundations of a theory of the
finance and the behavioral finance schools of thought. This is followed Miller (1958) valuation of firms in a world of
uncertainty.
by a description of various market anomalies that provide evidence for
Modigliani and Capital structure A modified model that still shows
the tendency of markets to trade at irrational levels. We then move on Miller (1963) quantitatively large differences from the
to a discussion of noise trading and noise trader risk, followed by an traditional model.
examination of how noise trading is related to some market fundamen- Sharpe (1964) Asset pricing In equilibrium there is a simple linear
tals. Next we present the theoretical models used to quantify noise trader relation between the expected return and
the standard deviation of return for
risk and the related empirical evidence before we finish with some efficient combinations of risky assets.
concluding remarks and suggestions for future research. Lintner (1965) Asset pricing Establishing conditions under which
stocks are held long (short) in optimal
2. Neoclassical finance versus behavioral finance portfolios even when risk premia are
negative (positive).
Fama (1965) Efficient market Stock prices follow a random walk process
Haugen (1999) describes the evolution of finance as a separate hypothesis such that the actual price of a security at any
discipline by identifying three schools of thought: old finance, modern point in time is a good estimate of its intrinsic
finance and new finance. The old finance school focused on financial value.
statement analysis and the nature of financial claims. Modern finance Fama (1970) Efficient market Evidence in support of the EMH is
hypothesis extensive while contradictory evidence is
focuses on asset pricing and valuation based on rational economic sparse.
behavior. Under this paradigm, the market is always efficient, and devi- Black and Scholes Option pricing The development, for the first time, of a
ations from fundamental values are expected to be short-lived as they (1973) model that gives a theoretical estimate of
are eliminated by arbitrage. In the 1980s several papers challenged the price of a European-style option.
Jensen and Capital structure The agency cost theory states that an
the modern finance doctrine, leading to the emergence of the new
Meckling (1976) optimal capital structure is determined by
finance school of thought in the 1990s. The new finance doctrine deals minimizing the costs arising from conflict
with inefficient markets, primarily by adopting behavioral models. In between the parties involved.
this paper we distinguish between neoclassical finance (modern finance), Myers and Majluf Capital Structure The pecking order theory of capital structure
as the mainstream discipline, and behavioral finance (new finance) as (1984) rejects the idea of a well-defined target debt
ratio.
the unorthodox discipline. Recently we witnessed the emergence of Fama and French Asset pricing Identification of three stock-market
“quantitative behavioural finance” as a discipline (see, for example, (1993) factors: an overall market factor and
Duran & Caginalp, 2007). factors related to firm size and
Statman (1999) identifies the pillars of neoclassical finance (which book-to-market equity.
Fama and French Asset pricing Except for the continuation of short-term
he calls “standard finance”) as being “the arbitrage principles of Miller
(1996) returns, the anomalies largely disappear in
and Modigliani, the portfolio principles of Markowitz, the capital asset a three-factor model. The results are
pricing theory of Sharpe, Lintner, and Black, and the option-pricing theory consistent with rational ICAPM or APT
of Black, Scholes, and Merton”. He describes the discipline as “compelling” asset pricing.
because “it uses a minimum of tools to build a unified theory intended to Subrahmanyam CAPM and Identification of some 50 variables that have
(2010) extensions been used in extensions of the CAPM.
answer all the questions of finance”. The neoclassical finance era started
 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100 91

Ramiah, 2015). Table 1 presents a timeline for the evolution of research ongoing debate on the profitability of the high-frequency tactical
on neoclassical finance. asset allocation strategy known as momentum trading (also known
Behavioral finance can be defined as the application of psychology to as return continuation). Jegadeesh and Titman (1993) and Lee and
explain market anomalies. The focus on interpersonal behavior and the
role of social forces in governing behavior is known as social psycholo-
Table 2
gy. According to Statman (1999), “people are rational in standard
Timeline of research evolution in behavioral finance.
[neoclassical] finance; they are normal in behavioral finance”. Behavior-
al finance models allow for the possibility that market participants can Author(s) Issue(s) Findings/Conclusions
make mistakes in their valuations (cognitive errors). Research in behav- Selden (1912) Psychology of Movements of stock prices are
ioral finance covers a variety of topics such as representativeness bias, the stock dependent to a considerable degree on
market the mental attitude of market
overconfidence, self-serving bias, gambler's fallacy, hindsight, panic,
participants.
herding behavior, status quo, survivorship bias, money illusion, loss aver- Festinger, Riecken, and Social A state of cognitive dissonance arises
sion, attachment, disposition effect, recovery, familiarity, illusion of con- Schachter (1956) psychology when two simultaneously held
trol, home bias, conservatism and even narcissism. In many respects the cognitions are inconsistent. Because
assumptions underlying behavioral finance models are similar to those the experience of dissonance is
unpleasant, the person will strive to
used to construct traditional models, but the following differences are
reduce it by changing beliefs.
observed: (i) investors do not simply look at mean-variance configura- Pratt (1964) Utility and A consideration of utility functions,
tions to make investment decisions as they may be influenced by other risk risk aversion and risk as a proportion
non-statistical characteristics such as taste, preference and other psycho- of total assets.
Tversky and Kahneman Judgmental Development of the availability
logical factors; (ii) investors may perceive trends even though no
(1973) heuristics heuristic postulating that a person
obvious pattern is present; (iii) imperfect information exists in the evaluates the frequency of classes or
presence of trader heterogeneity; (iv) different investors tend to have the probability of events by
different investment opportunities, depending on taste, while herding availability.
behavior may result in a common taste; and (v) the market is not Tversky and Kahneman Judgmental Three heuristics are employed to
(1974) heuristics make judgment under uncertainty:
necessarily in equilibrium, and while arbitrage opportunities exist they
representativeness, availability and
may be subject to market sentiment. anchoring.
Table 2 presents a timeline for the evolution of research in behavioral Kahneman and Tversky Prospect People underweight outcomes that
finance. One of the earliest contributions was made by Selden (1912) who (1979) theory are merely probable in comparison
suggested, long before the emergence of behavioral finance as a discipline with outcomes that are obtained with
certainty.
or school of thought, that stock price movements depended crucially on Thaler (1980) Prospect Advocating the use of prospect theory
the mental attitude of market participants. It was, however, Tversky and theory as an alternative descriptive theory.
Kahneman (1973, 1974, 1981) who made the most significant contribu- Tversky and Kahneman Judgmental Introduction of the concept of framing.
tions to the field, including the development of the heuristics of availabil- (1981) heuristics
Shiller (1981) Efficient The efficient markets model is at best
ity, representativeness, anchoring and framing. Their most important
market an “academic” model and does not
contribution, however, was the development of prospect theory (Tversky hypothesis describe observed movements in
and Kahneman, 1979), which Thaler (1980) advocated as an alternative financial prices.
descriptive theory. Shiller (1981) was the first to describe the efficient De Bondt and Thaler Market People overreact systematically to
market hypothesis (the backbone of neoclassical finance) as an “academic (1985) inefficiency dramatic news events, which results
in substantial weak-form
model that bears little to reality”. Significant contributions have been inefficiencies in the stock market.
made about the expected utility theory (Yaari, 1987), status quo bias Yaari (1987)) Expected Modification to expected utility theory
(Samuelson & Zechauser, 1988), loss aversion (Kahneman, Knetsch, & utility theory to obtains the “dual theory of choice
Thaler, 1990), the equity premium puzzle (Benartzi & Thaler, 1995), and under risk”.
Samuelson and Zechauser Status quo Decision making experiments confirm
the disposition effect (Odean, 1998a). Needless to say, this list of impor-
(1988) bias the presence of status quo bias.
tant contributions is not exhaustive. Kahneman et al. (1990) Loss aversion Loss aversion and the endowment
effect persist even in market settings
3. Market anomalies and evidence for irrational behavior with opportunities to learn.
Shefrin and Statman Noise trading There is a heterogeneous capital
(1994) market where noise traders tend to
In this section we demonstrate that the EMH does not necessarily distort certain principles of finance.
hold at all times, giving rise to irrational behavior. Various market The behavioral efficient market
anomalies are described to demonstrate that the behavior of market hypothesis is presented.
participants can be inconsistent with asset pricing models such as the Benartzi and Thaler Equity The puzzle is explained in terms of
(1995) premium behavioral concepts: loss aversion
CAPM, the Fama-French (1993, 1996) three-factor model and the
puzzle combined with a prudent tendency to
Carhart (1997) four-factor model. Neoclassical finance theories fail to monitor wealth frequently.
provide adequate explanation as to why anomalous behavior persists Odean (1998a) Disposition Investors have a tendency to sell
while behavioral finance theories provide psychological explanations effect wining investments too soon and hold
for observed market phenomena. Fig. 1 is a schematic representation losing investments for too long.
Holt and Laury (2002) Risk aversion A simple lottery choice experiment
of how biases (heuristics) lead to observed market anomalies. In the shows differences in risk aversion
remainder of this section we describe some market anomalies—a between behavior under hypothetical
summary of the relevant findings are reported in Table 3. and real incentives.
Harrison and Rutstrom Prospect Expected utility theory and prospect
(2009) theory theory can be reconciled by using a
3.1. Momentum profit
mixture model.
Frydman, Barberis, Realization Activity in two areas of the brain,
Both individual investors and institutional investors are exposed to Camerer, Bossaerts, and utility which are important for economic
the challenge of asset allocation. Brinson, Hood, and Beebower (1986) Rangel (2014) decision making, exhibit activity
and Vora and McGinnis (2000) discuss the complexity for an individual, consistent with the predictions of
realization utility.
even at the most basic level, of portfolio selection. At present there is an
92 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100
Fig. 1. Anomalies and biases.
Swaminathan (2000) argue that traders can take advantage of momen-
tum strategies by buying well-performing stocks while simultaneously
short-selling poor-performing stocks. This finding is not confined to
the U.S. market: Rouwenhorst (1998) observes momentum profits in
12 European countries, Rouwenhorst (1999) documents momentum
profits in emerging markets, Chan, Hameed, and Tong (2000) reveal
further evidence using 23 stock market indices, Hameed and Kusnadi
(2002) show similar behavior in Asian markets, and Connolly and
Stivers (2003) present evidence for the British and Japanese markets.
Another vein of the literature is concerned with explaining why this
market anomaly persists. For this purpose, researchers have used asset
pricing models, behavioral finance, macroeconomic factors, seasonality
and a restricted set of finance variables. Applying the three-factor
model, Fama and French (1998) fail to establish any relationship
between abnormal profits and three systematic risk factors. Behavioral
finance specialists, on the other hand, seek to explain observed momen-
tum profit with behavioral phenomena such as expectation extrapo-
lation (De Long et al., 1990), conservatism in expectations (Barberis,
Shleifer, & Vishny, 1998), biased self-attribution (Daniel, Hirshleifer,
& Subrahmanyam, 1998), disposition effect (Grinblatt & Han, 2005),
and selective information conditioning (Hong, Lim, & Stein, 2000).
Menkhoff and Schmidt (2005) describe momentum traders as investors
who seek to profit from trend analyses whereas Chordia and
Shivakumar (2002) find that momentum strategies perform well
when macroeconomic conditions are good and that momentum profit
Table 3
Evidence on market anomalies.
Anomaly Findings/Conclusions
Momentum profit Momentum profit persists across various stock markets,
which provides a challenge to the efficient market hypothesis.
While some explanations have been put forward for why
momentum profit arises, little work has been done to explain
momentum profit in terms of noise trader risk.
Contrarian profit Contrarian profit is produced by naïve investors who pay
attention to recent information only. Extensive literature
supports the presence of contrarian profit in markets around
the world.
Overreaction Overreaction occurs when traders either overweight present
information or underweight past information. The literature
detects overreaction and explains why it arises. Noise trading
does not appear to explain overreaction.
Underreaction Interaction between information traders and noise traders
leads to underreaction. The literature suggests that investors
do not fully incorporate earning announcements into asset
pricing. Underreaction may subsequently lead to overreaction
and momentum profit.
Information Pricing errors are caused by overconfidence and
pricing errors self-attribution bias. The evidence shows that trading
volume is higher following periods of high returns as
investment success leads to a higher degree of
overconfidence.
Technical analysis Technical analysis is used to detect “illusory correlation”.
Trading volume is 60 per cent higher following the
emergence of head-and-shoulders patterns.
 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100
depends on trading volume, earnings and the size of the underlying
firm.
The following lessons can be drawn from the literature:
(i) momentum profit persists across various stock markets, (ii) the
evidence provides a challenge to the efficient market hypothesis,
(iii) the first wave of studies tend to detect momentum profits across
various markets while the second wave focus on explaining why
momentum profit arises, (iv) momentum studies have attracted
increasing interest from finance academics, and (v) little work has
been done to explain momentum profit in terms of noise trader risk.
3.2. Contrarian profit
Lo and MacKinlay (1990) define a contrarian investment strategy as
one that exploits negative serial dependence in asset returns by buying
poorly-performing stocks and short-selling well-performing stocks. De
Bondt and Thaler (1985) were pioneers in suggesting the notion of
contrarian profit. They challenge the efficient market hypothesis by
arguing that contrarian profit is produced by naïve investors who tend
to pay more attention to recent information and less attention to prior
information, resulting in overreaction. As in the case of the momentum
anomaly, the profitability of contrarian strategies is supported by exten-
sive literature. Several studies document contrarian profit in European
markets, including Brouwer, Van Der Put, and Veld (1997)—covering
France, Germany, Netherlands and the U.K.—Mun, Vasconcellos, and
Kish (1999) who examine markets in France and Germany; Forner
and Marhuenda (2003) who study the Spanish stock market; Novak
and Hamberg (2005) who investigate the Swedish market; and
Antoniou, Galariotis, and Spyrou (2005) who conduct similar work
on the Greek market. In the Asia Pacific region, Chin, Prevost, and
Gottesman (2002) find contrarian profit in New Zealand; Yoshio,
Hideaki-Kiyoshi, and Toshifumi (2004) and Chou, Wei, and Chung
(2007) document contrarian behavior in Japan; Hameed and Ting
(2000) examine the Malaysian stock market; Lo and Coggins (2006)
and Ramiah, Mugwagwa, and Naughton (2011b) report contrarian
profit in Australia.
Numerous papers document the presence of contrarian profit in the
Chinese market. For instance, Kang, Liu, and Ni (2002) find statistically
significant short-term contrarian profit in China while Otchere and
Chan (2003), Fung (1999) and Ramiah, Cheng, Orriols, Naughton, and
Hallahan (2011a) report contrarian profit in the Hong Kong market.
By following the methodology of De Bondt and Thaler (1985), Otchere
and Chan (2003) detect a small but significant degree of overreaction
prior to the advent of the Asian financial crisis. They argue that price
reversals are more pronounced for winners than for losers, an observa-
tion that they attribute to cultural differences. Ramiah et al. (2011a)
investigate the possibility of generating contrarian profit from stocks
that are cross-listed in Hong Kong, Mainland China, Australia, U.K.,
U.S., Singapore and Europe. They document contrarian profit as high
as 8.01 per cent per month for dually-listed stocks. The literature
strongly supports the proposition that contrarian trading behavior is
present in the Chinese stock market.
3.3. Overreaction
Research in experimental psychology suggests that overreaction
occurs when traders assign too much weight to present information
or too little weight to past information. De Bondt and Thaler (1985)
present the leading empirical study of the overreaction hypothesis,
providing evidence that challenges the efficient market hypothesis.
Subsequent papers, such as Chopra, Lakonishok, and Ritter (1992),
reinforce the findings of De Bondt and Thaler in terms of asymmetry
in overreaction, suggesting that individuals tend to overreact more
than institutions as individuals predominantly hold small-firm stocks
whereas institutional traders hold large-firm stocks. Further evidence
in support of the overreaction hypothesis has been produced by
93
Lakonishok, Shleifer, and Vishny (1994), Dreman and Berry (1995),
Lobe and Rieks (2011) and by Farag (2014).
As is the case with other anomalies, the literature is about detecting
overreaction and explaining why it arises. Odean (1998b) and Graham,
Harvey, and Huang (2009) use psychological factors to point out that
overconfident investors tend to overrate their own beliefs, which in
turn leads to excessive trading. Barberis et al. (1998) develop a model
to examine the role of both overreaction and underreaction and use
the Tversky and Kahneman (1974) finding of representativeness bias
to explain overreaction. Chen, Rui, and Wang (2005) show that Chinese
investors have a tendency to overreact to good news and underreact to
bad news in a bullish market. Ramiah and Davidson (2007) introduce
the information-adjusted noise model to explain how noise traders
overreact to news arrival. They show that there is a relatively low
level of overreaction to news arrival in the Australian market. The
literature indicates that while noise trading does not appear to explain
overreaction, strong evidence indicates that it explains underreaction.
3.4. Underreaction
Ramiah and Davidson (2007) show that interaction between
information traders and noise traders leads to underreaction in the
Australian stock market. They study interaction between the two
categories of traders over the period 2000–2002 where they consider
the arrival of 12,273 information items pertaining to 46 stocks. They
test market efficiency on a daily basis by determining whether
underreaction, information pricing error (IPE) or overreaction prevails,
breaking down these different effects into positive and negative. Their
findings show that the efficient market hypothesis holds in 40 per
cent of the cases. They conclude that noise traders appear to be present
in the market in 60 per cent of the cases, classified into five per cent
overreaction, 25 per cent underreaction and around 35 per cent of IPE.
Underreaction to firm-specific information is not a new phenomenon
as there is some literature on how investors react to accounting and finan-
cial information. A significant portion of the literature suggests that inves-
tors do not fully incorporate earnings announcements into the pricing of
assets—examples of these studies are Ball and Brown (1968), Bernard and
Thomas (1989), Bartov (1992), Narayanamoorthy (2006) and, more
recently, You and Zhang (2011). Another recent study by Fischer
(2012), which explores underreaction in certain sectors, finds that
while traders underreact to earnings news (captured by post-earnings
announcement drift), they overreact to product news in the form of
subsequent stock price reversals. It is worth noting that certain
studies—such as You and Zhang (2011) and Bernard (1992)—detect
both overreaction and underreaction.
Earlier papers, such as Bernard (1992), highlight the presence of
underreaction, which in turn can cause overreaction, implying that
traders tend to underreact to initial earnings announcements and over-
react subsequently. Studies carried out by Freeman and Tse (1989),
Bernard and Thomas (1990), Wiggins (1991), Mendenhall (1991), and
by Abarbanell and Bernard (1992) suggest that post-announcement
drift occurs because asset prices fail to reflect current levels of earnings,
which means that subsequent earnings announcements come as a
surprise to market participants. This framework involves a naïve expec-
tation model where prices are predictable, implicitly implying that fore-
casting errors can be either positively or negatively autocorrelated.
Bernard (1992) is intrigued by the existence of a naïve expectation
approach, as he wonders why such a trend/autocorrelation in the lags
does not disappear. He argues that there may be some other kind of
systematic risk factors (including noise trader risk) that prevent reversals.
The noise trader risk argument is also supported by Andreassen (1987)
who suggests that certain systematic psychological forces can influence
price behavior.
Support for the underreaction hypothesis is found by Cutler, Poterba,
and Summers (1991) who examine autocorrelation in various indexes
for different horizons and report positive autocorrelation in excess
94 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100
returns for holding periods of 1 to 12 months. Evidence of autocorrelation
is used to support the underreaction hypothesis, implying a delayed
reaction as prices adjust slowly to new information (hence the emergence
of trends in returns). Bernard and Thomas (1990) observe positive
autocorrelation in earnings in the first three quarters and a change into
negative autocorrelation in the fourth quarter—such outcome is perceived
as a mean-reverting process. Jegadeesh and Titman (1993) provide
further evidence as they detect autocorrelation over a 6-month horizon
where such evidence is linked to momentum profit. The underreaction
hypothesis is used to explain momentum profit on the grounds that
slow adjustment to new information leads to return continuation,
which means that winners continue to be winners and losers continue
to lose.
Following Edwards (1968), Barberis et al. (1998) use conservatism
bias to explain underreaction. Within the cognitive psychology literature,
conservatism is a bias that may occur when human beings process
information such that there is a tendency to rely more on previous
knowledge/information and less on new information. When applied to
the stock market, conservatism may make traders adjust slowly to new
information. The recent literature shows that investors tend to underreact
to announcements about earnings, dividends, stock splits and others. In
their experiment, Barberis et al. find that individuals have a tendency to
update their posteriors in the right direction but by a smaller magnitude
than what is required where the right direction and magnitude are
provided by a Bayesian framework.
3.5. Information pricing errors
The implication of the efficient market hypothesis is that informa-
tion traders are sophisticated market participants who end up making
the right investment decisions. Recent evidence, however, challenges
this proposition. For instance, Ramiah and Davidson (2007) detect in-
formation pricing errors whereby information traders end up becoming
noise traders. A significant portion of the literature demonstrates that
professionals tend to make mistakes while another part of the literature
explains why they make mistakes.
Cordell, Smith, and Terry (2011) argue that the dual burden phe-
nomenon explains why professionals make errors. This phenomenon
refers to the instance where people with less experience believe that
they know more with greater certainty than people who have more
experience. Cordell et al. compare two groups of financial planners:
the first group has earned one certification whereas the second group
has more than one qualification and specialized skills. They report that
the first group (with less knowledge) tends to be more confident, giving
rise to the “dual burden phenomenon”. Griffin and Tversky (1992) show
that when predictability is low, financial analysts might even be more
overconfident than the novices because they put too much faith into
the models and theories in which they believe.
Overconfidence as a phenomenon in the work place has been docu-
mented by Frank (1935) who reported that traders were overconfident
about their ability and that overconfidence increased with the personal
importance of the task. Abreu and Mendes (2012) investigate the rela-
tionship between investors' overconfidence and trading frequency,
demonstrating that both overconfidence and non-overconfidence in
information results in more trading. They contribute to the litera-
ture by showing that overconfident investors trade less frequently
when they collect information via family and friends whereas non-
overconfident investors trade more frequently when they use
specialized sources of information. Their findings are consistent
with the behavioral finance literature in that overconfidence boosts
trading volume. For example, Statman, Thorley, and Vorkink (2006)
provide evidence indicating that trading volume is higher following
periods of high returns as investment success leads to a higher degree
of overconfidence. De Bondt and Thaler (1995) argue that overconfi-
dence is an important behavioral factor that explains the trading puzzle
whereas Odean (1998b) argues that a high level of trading volume,
volatility and irrational prices are consequences of overconfidence.
Barber and Odean (2001) suggest that men are more overconfident
than women—consequently, men tend to trade more than women.
Ahmed and Duellman (2013) show that overconfident managers tend
to overestimate future returns on their firms' investments and that
they have a tendency to delay loss recognition.
Self-attribution bias is another behavioral bias that explains why
professionals make sub-optimal decisions—in this case because people
tend to have unrealistically positive views about themselves (Taylor &
Brown, 1988). The behavioral finance literature shows that the effect
of this bias is similar to that of overconfidence bias whereby traders
tend to trade excessively (Deaves, Lüders, & Luo, 2009; Glaser & Weber,
2007; Graham et al., 2009). Like overconfidence, self-attribution makes
investors trade below the optimal trading point, leading to excessive
trading and mistakes.
3.6. Technical analysis
The efficient market hypothesis dictates that investors cannot earn
abnormal returns consistently when they trade on the basis of historical
data. Technical analysts use charts to discern patterns that help them
make their investment decisions—one of these patterns is the head-
and-shoulders formation. Bender et al. (2013) use the head-and-
shoulders pattern to identify “illusory correlation” in financial markets.
They provide evidence indicating that technical analysis is alive and
well, reporting that trading volume is over 60 per cent higher than nor-
mal around the time when head-and-shoulders patterns are observed.
However, they provide evidence indicating that trading on these signals
is not profitable, suggesting that this technique is an “illusion”. They
explain that their findings about head-and-shoulders trading fit
Black's (1986) description of those who trade on noise as if it was
information. They conclude that, in aggregate, technical analysis
contributes significantly to noise trading.
Campbell, Lo, and MacKinlay (1997) refer to technical analysis as the
“black sheep of the academic finance community.” Nevertheless, when
we look at the growing literature about momentum and contrarian
profit, we can see that technical analysis is becoming a matter of interest
for many finance academics. Kavajecz and Odders-White (2004) report
that most investment banks and trading firms employ traders who rely
on technical analysis—the fact that these institutions are willing to
invest in technical analysis implies that some benefits are associated
with this technique. We gather from the studies of Park and Irwin
(2007) and Billingsley and Chance (1996) that about 60 per cent of
commodity trading advisors and between 30 and 40 per cent of currency
traders use technical analysis as a major tool in the decision making
process. Sturm (2013) discusses the issue of whether market efficiency
and technical analysis can co-exist and argues that the presence of
noise traders leads to deviations from fundamentals.
4. Noise trading
Trading usually takes place when market agents assign different
values to a particular asset. Following Black (1986) and Shefrin and
Statman (1994), two categories of traders are present in the market: in-
formation (sophisticated) traders and noise traders. Shefrin and
Statman (1994) argue that information traders act on the basis of funda-
mental information and process information rationally. The term “noise
traders” appears frequently in popular financial websites—in other
words, it has become a household expression. In Table 4 we present
some definitions of noise traders taken from some popular websites as
well as some formal definitions taken from academic articles.
A number of studies have shown that trading on information
is profitable, including Easley, Hvidkjaer, and O’Hara (2002);
Vachadze (2001); Blair, Poon, and Taylor (2001); Gervais, Kaniel,
and Mingelgrin (2001); Pritamani and Singal (2001); Chen, Mohan,
and Steiner (1999); Atkins and Basu (1995); Berry and Howe
 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100 95

Table 4
Popular and formal definitions of noise traders.

Author Definition

Invesopedia (http://www.investopedia.com/terms/n/noisetrader.asp) Investors who make decisions regarding buy and sell trades without the use of fundamental data.
These investors generally have poor timing, follow trends, and overreact to good and bad news.
Wikipedia (http://en.wikipedia.org/wiki/Noise_trader) A noise trader is a trader whose decisions to buy, sell or hold are irrational and erratic.
Financial Dictionary A noise trader is an investor who makes decisions on feelings, such as fear or greed, rather than
(http://financial-dictionary.thefreedictionary.com/Noise+Trader+Risk) fundamental or technical changes to a security.
Financial Dictionary A trader that makes investment decisions based on perceived market movements rather than a
(http://financial-dictionary.thefreedictionary.com/Noise+Trader) security's fundamentals. A noise trader buys when everyone else seems to be buying and sells
when everyone else seems to be selling.
Investwords (http://www.investorwords.com/11717/noise_trader.html) Investors who make their trading decisions without using any fundamental data. Typically, they
have poor timing and are much more apt to overreact to good or bad news about their investments.
Personal Finance (http://www.pfhub.com/noise-trader/) A noise trader as an investor who bases investment decisions on trends prevailing in the market
rather than fundamental factors and information.
Bloomfield, O’Hara, and Saar (2009) Noise traders do not possess fundamental information and have no exogenous reasons to trade.
De Long (2005) Noise traders trade on bad information or no information at all.
Tetlock (2006) Noise traders are agents who have hedging motives or irrational reasons to trade.
Osler (1998) Noise trading is not rationally based on the arrival of new information about asset values.

(1994); and Penman (1987). Unlike other behavioral finance segments,
the noise trading literature is relatively thin although it has been growing
rapidly since 2000. Noise traders have been identified as a major source of
volatility, giving rise to what may be called “noise trader risk”. Black
(1986) provides a definition for noise traders but fails to develop a
model that captures noise trading effects.
Lee et al. (1991) attempt to capture the behavior of noise traders by
studying closed-end funds where typically a large pool of small inves-
tors conducts business. Closed-end funds, which are listed on major
stock exchanges, invest almost exclusively in the securities of other
publicly traded companies. The price of a closed-end fund tends to differ
from net asset value, which is referred to as the “closed-end fund
puzzle”. Lee et al. suggest a behavioral finance explanation in terms of
“differential clienteles” whereby individual investors prefer mutual
funds while institutional investors choose individual stocks to replicate
the portfolios. If small investors trade more on the basis of noise, then
the closed-end funds become more risky, which explains the discount
compared to the replicated portfolio. One implicit assumption underly-
ing this argument is that small investors trading on noise alter system-
atic risk, which triggers a discussion of the risk associated with noise
trading—that is, noise trader risk. De Long et al. (1990) argue that the
discount could be regarded as a measure of sentiment in the market,
indicating that when noise traders are excessively bullish, the discount
should decline—the reverse is expected when noise traders are bearish.
Bodurtha, Kim, and Lee (1995) find that changes in country-fund
discounts reflect the risk associated with the sentiment of U.S. investors.
Brown (1999) shows that unusual levels of individual investor senti-
ment are associated with greater volatility of closed-end funds. Muller
and Pfnuer (2013) examine the net asset value spread in real estate in-
vestment trusts (REITs) and postulate that the price of REITs may reflect
noise traders' sentiment.
Brown (1999) supports the hypothesis that irrational investors
acting on noisy signals could cause systematic risk while Odean
(1998b) shows that volatility goes up with the intensity of noise trading.
Nguyen and Daigler (2006) find that uninformed traders cause exces-
sive variability in trading volume when they face return or volatility
shocks. De Long et al. (1990) argue that under certain conditions,
noise traders may earn more than rational traders—nonetheless, this
may not be due to the skills of rational investors but most likely because
they assume greater risk exposure. Furthermore, they show that some
“sophisticated users” (informed traders) convert into noise traders as
it pays to do so.
Following Shleifer and Summers (1990) and De Long et al. (1990),
noise trader risk has to be evaluated in addition to basic market volatil-
ity. Several models have been developed to measure the volatility
caused by noise traders at the start of the third millennium. Lee, Jiang,
and Indro (2002) use the Investors' Intelligence of New Rochelle as a
sentiment proxy and a series of independent advisory services rated
by the editor of Investors' Intelligence. They estimate a GARCH model
to evaluate the impact of sentiment on return and volatility to demon-
strate that changes in sentiment are negatively correlated with condi-
tional volatility, implying that volatility goes up when investors
become more bearish, and vice versa. However, Verma and Verma
(2006) suggest that volatility is more affected by bullish sentiment by
using the sentiment index of the American Association of Individual
Investors (AAII) and an EGARCH model to check for asymmetric effects.
Wang, Li, and Lin (2009), on the other hand, employ other models (such
as GJR-GARCH, EGB2 and SWARCH models) to explore the effects of
investor sentiment on the Taiwan Futures Exchange. Using an
EGARCH model, Uygur and Taş (2014) investigate the proposition that
earnings shocks have more influence on conditional volatility in high
sentiment periods in the U.S., Japan, Hong Kong, U.K., France, Germany
and Turkey. They find that earnings shocks have more influence on
conditional volatility when sentiment is high.
Low (2004) argues that noise traders can inflate asset price volatility,
particularly during market downturns, which creates a debate on asym-
metric volatility. Avramov, Chordia, and Goyal (2006) argue that asym-
metric volatility is governed by the trading dynamics of informed and
uninformed traders although they do not have a direct measure of in-
formed and uninformed trades. They assume that selling activity on
negative-return days is dominated by uninformed (noise) traders and
that selling activity on positive-return days is dominated by informed
traders. Kittiakarasakun, Tse, and Wang (2012) confirm the findings of
Avramov et al. (2006) by using the trader identification of the computer
trade reconstruction data set, which distinguishes between informed
and uninformed trades. Likewise, Baklaci, Olgun, and Can (2011) show
that noise traders contribute significantly to volatility in spreads and
that the volatility impact is short lived.
Currently there is an on-going debate on whether or not market
sentiment reflects the behavior of noise traders, but there is no general
consensus on this issue. A number of researchers refer to market senti-
ment effects as noise trading. In their explanation of the closed-end fund
puzzle, Lee et al. (1991) argue that the risk factor caused by small inves-
tors may account for the difference between the net asset value and the
price of the fund, suggesting that this can be used as evidence that noise
trader risk is priced. Using the Michigan consumer confidence index as a
proxy for investor sentiment, Lemmon and Portniaguina (2006) show
that consumer confidence explains time variation in equity portfolio
returns—this proposition is supported by other studies such as Baker
and Wurgler (2006) and Qiu and Welch (2004).
Baker and Wurgler (2007) estimate a different sentiment index by
averaging six widely accepted proxies: trading volume, dividend
premium, closed-end fund discount, the number and first-day returns
on IPOs, and the equity share in new issues. Each proxy is regressed
96 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100
on macroeconomic variables such as industrial production, growth
in employment, and a recession indicator to filter out the effects of
macroeconomic news. Their results show that in periods of low (high)
sentiment, speculative stocks have greater (lower) future returns on
average than bond-like stocks.
Brown and Cliff (2005) also explore the relationship between inves-
tor sentiment and return and report that previous returns are important
determinants of sentiment indexes. Aase, Bjuland, and Øksendal (2012)
show that noise traders do not lose on average while informed investors
make zero expected profit. Davidson and Ramiah (2010) use two differ-
ent proxies for noise trading, the change in behavioral error and the
residual behavioral error after controlling for firm-specific information.
They find evidence that these two proxies are related to return and con-
tend that the absence of a relationship between noise trader behavior
and return implies that the market is behaviorally inefficient. They
also identify a positive relationship as “systematic noise effect” and a
negative relationship as “cash noise effect”.
5. Noise trading and fundamentals
Ramiah and Davidson (2007) argue that using a sentiment index to
capture the behavior of noise traders is not sufficient as various factors
(such as firm-specific information, portfolio rebalancing and liquidity)
affect trading behavior. To that end, they control for the arrival of
firm-specific information in their measure of noise trader risk. The
literature on how firm-specific information affects noise trading is
rather thin. In the accounting literature, on the other hand, Chau,
Dosmukhambetova, and Kallinterakis (2013) study the relationship
between International Financial Reporting Standards (IFRS) and noise
trading. They report that the adoption of IFRS has enhanced the stability
and informational efficiency of capital markets by promoting
information-based trading, which has the effect of reducing the impact
of noise traders. In the remainder of this section we discuss some of the
relevant factors while Table 5 reports a summary of the relevant
findings.
5.1. Volume
Kyle (1985) argues that in continuous auction equilibrium the
quantity traded by noise traders follows a Brownian motion process.
This observation implies that an ex ante doubling of the quantities
traded by noise traders induces insiders and market makers to double
the quantities they trade without exerting any effect on prices, leading
to the doubling of profits for insiders. Campbell, Grossman, and Wang
(1993) find that trading volume and stock return autocorrelations are in-
versely related, suggesting that rational, risk-averse market participants
Table 5
Evidence on the role of firm-specific information.
Indicator Findings/Conclusions
Trading The literature does not address adequately the issue of how
volume volume and noise trading are related. Trading volume and return
autocorrelations are inversely related, giving rise to the tendency
of informed traders to accommodate the market pressure created
by noise traders.
Earnings Very little in the literature on how earnings affect noise trader
risk, and vice versa.
Firm size Despite the importance of firm size in the Fama-French model,
the literature hardly deals with the issue of whether noise traders
are found more (or less) in the markets for large or small stocks.
Leverage Although the finance literature deals with leverage extensively,
particularly in theories of capital structure, the literature is silent
on how the behavior of noise traders is influenced by leverage.
Capital The literature does not examine the relation between capital
expenditure expenditure and the behavior of noise traders.
Sales While it is intuitive that negative sales announcements should be
expected to reduce profitability, the literature does not examine
the issue of how sales affect the behavior of noise traders.
have a tendency to accommodate the buying and selling pressures of
uniformed investors or noise traders. Odean (1998b) provides evidence
suggesting that overconfidence boosts trading volume and volatility,
leading to underreaction. Song, Tan, and Wu (2005) find that the
relationship between volatility and volume on the Chinese stock market
is driven mainly by the number of trades.
Furthermore, Groenewold, Tang, and Wu (2003) observe a contem-
poraneous V-shaped relationship between stock returns and market
turnover in the Shanghai, Shenzhen and Hong Kong stock markets.
Dennis and Mayhew (2002) investigate the relative importance of
factors such as leverage ratio, volume and firm size to explain volatility,
finding evidence for positive correlation between size and volume. They
also find that the problem of multicollinearity cannot be ignored in
studies involving various fundamentals. There is rich literature on
trading volume, but this literature does not address adequately the
issue of how volume and noise trading are related.
5.2. Earnings
In an early piece of research, Ball and Brown (1968) develop the link
between earnings announcements, expectations and stock prices. Other
studies—such as Rendleman, Jones, and Latane (1982) and Easton and
Harris (1991)—use earnings as an explanatory variable for stock returns.
Copeland, Dolgoff, and Moel (2004) support prior studies in that they
find significant results when a cross-section of market-adjusted stock
returns is regressed on changes in analyst expectation of short-term
and long-term earnings. Uygur and Taş (2014) show that bad news
(negative earnings shocks) cause more volatility than good news
(positive earnings shocks). Like trading volume, the literature on
earnings is extensive, but there is almost no literature on how earnings
affect noise trader risk, and vice versa.
5.3. Firm size
Fama and French (1993, 1996) posit that a three-factor model largely
captures average returns on U.S. stock market portfolios—this observa-
tion is confirmed by Chui and Wei (1998). Drew, Naughton, and
Veeraraghavan (2003) extend this literature by showing a relationship
between firm size, book-to-market equity and average stock returns
for several Asian markets. Furthermore, they show that small and
growth firms generate superior returns as compared with those of big
and value firms. The first study of Fama and French triggered a debate
among finance academics over the three factors. Unfortunately, the liter-
ature hardly discusses the issue of whether noise traders prevail in the
market for large, small, value or growth stocks.
5.4. Leverage
If we start with the classic work of Modigliani and Miller (1963) and
Miller (1977), we find that a tax shield on interest payments on debt
places a premium on the value of a firm. However Miller's subsequent
incorporation of personal tax effects greatly reduces the tax advantages
of debt. Modigliani (1982) contributed to this literature by suggesting
that an optimal capital structure may involve a trade-off between tax
shelters on debt, inflation, and personal tax effects. Few years later,
Myers and Majluf (1984) presented the pecking order theory to explain
the tendency to rely on internal funds and the preference for debt rather
than equity. Myers (1977, 1984) and Flannery (1986), inter alia, focus
on long-term financial management. Bowman (1980) shows empirical-
ly that market value measurement of owners' equity is important for the
assessment of the effect of financial leverage on risk. He finds that the
market value of debt does not appear to be important, which can be
attributed to noise. Ryan (1997) finds that systematic risk is positively
associated with financial leverage. The findings of Barkham and Ward
(1999) imply that property stocks are likely to provide return that can
differ markedly from the return on the underlying assets over a relatively
 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100
long period of time. Although leverage is a major component of the
finance literature, the relationship between leverage and noise trading
is rarely, if at all, examined.
5.5. Capital expenditure
Yang-Tzong, Alt, and Gordon (1993) contend that cost-cutting exer-
cises in inefficient capital expenditure tend to have a positive effect on
the market value of firms. On the other hand, Copeland et al. (2004)
fail to find a statistically significant relationship between the return on
shareholders' equity and capital expenditure. Surprisingly the literature
on capital expenditure is relatively thin compared to other factors such
as debt and firm size. We do not find any consideration of the relation-
ship between noise trading and capital expenditure.
5.6. Sales
There is no literature to date on how noise trader risk is related to
sales. The rationale for adding this variable can be found in a preliminary
study conducted by Ramiah et al. (2011b) that considers sales
announcements by loser firms. They assume that traders acting on fun-
damentals incorporate a firm's sales figures into their asset allocation
decisions. Intuitively, any negative sales announcement would be
expected to reduce profitability expectations for firm.
6. Quantifying noise trader risk
Several studies have been conducted to quantify noise, including
Sias, Starks, and Tinic (2001), De Long et al. (1990), Osler (1998), Lee
et al. (2002), Verma and Verma (2006), Ramiah and Davidson (2007)
and Hu and Wang (2013). Others incorporate noise trading in their
models, including Blume and Easley (1994), Barberis et al. (1998),
Daniel et al. (1998) and Shefrin and Statman (1994). Sias et al. (2001)
use closed-end funds as their testing grounds, which represents a limi-
tation in the sense that other categories of listed companies are
overlooked. Osler (1998) identifies noise traders in the U.S. market
using the “head-and-shoulder” chart pattern—again, this model is limited
to trading based on technical analysis. Lee et al. (2002), Verma and
Verma (2006) and Hu and Wang (2013) fail to control for the effects of
firm-specific factors. The rest of this section focuses on Ramiah and
Davidson (2007) and Davidson and Ramiah (2010) as a continuation of
the work of De Long et al. (1990) and Shefrin and Statman (1994).
The model proposed by De Long et al. (1990) can be represented by
two equations:
rþt ptþ1 −ð1 þ r Þpt
λst ¼

2γ t σ 2ptþ1
rþt ptþ1 −ð1 þ r Þpt ρ
λnt ¼
 þ
t 
2γ t σ ptþ1
2 2γ t σ 2ptþ1
where λst is the demand for risky assets by informed traders, λnt is the
demand for risky assets by noise traders, r is a fixed dividend, pt is the
stock price at time t, γ is the coefficient of absolute risk aversion and
t σ ptþ1 is the one-period variance of pt + 1 at time t. It is assumed that
2
informed investors at time t perceive correctly the distribution of
returns from holding risk assets. Noise traders, on the other hand,
misperceives the expected price of a risky asset by an independently


and identically distributed normal random variable, ρt~:N ρ ; σ 2p ,
where ρ⁎ is a measure of the average “bullishness” of noise traders and
σ 2p is the variance of noise traders' misperception of the expected return
per unit of the risky asset or some element of noise trader risk. It is
assumed that noise traders maximize their expected utility, given
next-period dividend, the one-period variance of pt + 1, and their false
97
belief that the distribution of next-period price has a mean ρt above its
true value. The implication of the work of De Long et al. is that an
element of noise trader risk, which neoclassical finance fails to consider,
leads to a misspecified CAPM.
To that end, Shefrin and Statman (1994) develop a behavioral asset
pricing model (BAPM), which allows for heterogeneous traders and
produces behavioral beta, consisting of the traditional beta and noise
trader risk. BAPM is similar to the traditional CAPM, except that that
the market portfolio is proxied by a sentiment index. The CAPM is
represented by
 
~r it −~rft ¼ α i þ βCi ~r mt −~r ft þ ~εit ð3Þ
where ~r it is the return on asset i at time t, ~r ft is the risk- free rate at time t,
~r mt is the market return at time t, ~εit is the error term, αi is the intercept
of the regression equation and βCi is the CAPM beta. Eq. (3) can be
re-written by replacing the CAPM beta with the behavioral beta (βBi )
or and the noise element (ηi). Hence

 
~r it −~rft ¼ α i þ βBi þ ηi ~r mt −~r ft þ ~εit ð4Þ
where the noise element (ηi), which is referred to as behavioral error
(BE), can be expressed as the difference between the CAPM beta and
the BAPM beta. This gives
BEi ¼ ηi ¼ βCi −βBi ð5Þ
The BAPM of Shefrin and Statman (1994) is used to estimate the
behavioral beta from the following equation
h i
~r it −~rft ¼ α i þ βB ~r Bmt −~r ft þ ~εit ð6Þ
where ~r mt is the return on the behavioral market portfolio, which is
B
represented by a sentiment index made up of the “preferred stocks” of
small investors.
The methodology used to calculate BE involves the assumption that
indices would change only when there is a divergence in opinion caused
by irrational traders but fails to allow for new information arrival. To
extract firm-specific information from BE, Ramiah and Davidson
(2007) employ the information-adjusted noise model, which is written
as
ΔBEit ¼ α þ γINFOit þ εit ð7Þ
where INFO is a dummy variable that takes the value of one when there
is a news announcement and zero otherwise. α is the mean change in
ð1Þ
the behavioral error caused by noise traders, γ is a measure of the con-
tribution of information traders to the behavioral error, and μ = α + γ
reflects the net change in the behavioral error following the interaction
ð2Þ between noise and information traders—hence μ is a measure of noise
trader risk. This model can be used to detect overreaction, underreaction
and IPE.
Davidson and Ramiah (2010) go one step further to find out if the
proxies for noise trader risk (BE and μ ) are related to the return on
the underlying asset. For this purpose they use the following equations
in which return is a function of noise trader risk:
~r it ¼ ϕ1;i þ ϕ2;i ΔBEt−1 þ ~εit ð8Þ
~r it ¼ φ1;i þ φ2;i μ t−1 þ ~εit
ð9Þ
When Ramiah and Davidson (2007) apply their model to the
Australian market, they find the market to be efficient 37 per cent of
the times and observe IPE (33 per cent), underreaction (24 per cent)
and overreaction (6 per cent) as market inefficiency. Xu, Ramiah,
Moosa, and Davidson (in press) apply the model to the Chinese
98 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100
market and report pronounced market inefficiency with overreaction
(40 per cent), underreaction (18 per cent) and IPE (42 per cent). Both
of these studies show that noise trader risk is priced to a certain degree.
7. Conclusions and future remarks
This paper has outlined some major market anomalies that may
indicate irrational trading. One possible cause of these anomalies is
noise trader risk, which was not a very well-documented area prior to
the year 2000. Since then, we have seen a number of papers attempting
to quantify the impact of noise trading on financial prices.
According to the literature, there are reasons to believe that traders
do not operate rationally. While mainstream neoclassical finance trivial-
izes the effects of noise trading, the growing interest in the area of
behavioral finance has triggered a wave of studies to acknowledge and
explain noise trading. In particular, we have seen a growing number
of papers in the area of quantitative behavioral finance, of which we
attempted a selective survey in this paper.
The lessons that we have learnt from this review is that markets are
not always efficient as indicated by the presence of market anomalies,
which can be explained in terms of noise trader risk. Although it has
been highlighted on numerous occasions, to this date no attempt has
been made to explain a market anomaly by using noise trader risk,
with the exception of the closed-end fund puzzle. Several models have
been proposed to quantify noise trader risk, but the application of
some of these models is too restrictive while others are misspecified
(in terms of not controlling for firm-specific information).
So, where do we go from here? Numerous research avenues exist in
the field of behavioral finance in general and the specific topic of noise
trading. A number of biases have not been investigated to the same
extent as representativeness, loss aversion, overreaction and conserva-
tism. Hence more research needs to be conducted, inter alia, on panic,
recovery and status quo. A recent trend that has opened extensive
opportunities for research in behavioral finance is the use of neurosci-
ence to analyze financial decision making (for example, Bossaerts,
2009). As far as noise trading is concerned, we have already stated
that further research is required into how noise trading is related to
fundamentals and firm-specific information—in particular identification
of the fundamental factors that noise traders react to. Other areas of
future research about noise trading include a comparative study of
noisy markets and the inclusion of a noise trader risk factor in a multi-
factor asset pricing model. Last, but not least, high-frequency trading
is attracting significant attention (for example, Moosa, in press). It
would be interesting to investigate if and how high-frequency trading
leads to noise trading activity.
References
Aase, K. K., Bjuland, T., & Øksendal, B. (2012). Partially informed noise traders.
Mathematics and Financial Economics, 6, 93–104.
Abarbanell, J. S., & Bernard, V. L. (1992). Test of analysts overreaction/underreaction to
earnings information as an explanation for anomalous stock price behavior. Journal
of Finance, 47, 1181–1227.
Abreu, M., & Mendes, V. (2012). Information, overconfidence and trading: Do the sources
of information matter?’. Journal of Economic Psychology, 33, 868–881.
Ahmed, A. S., & Duellman, S. (2013). Managerial overconfidence and accounting conserva-
tism. Journal of Accounting Research, 51, 1–30.
Andreassen, P. (1987). On the social psychology of the stock market: Aggregate attributional
effects and the regressiveness of prediction. Journal of Personality and Social Psychology,
53, 490–496.
Antoniou, A., Galariotis, E. C., & Spyrou, S. I. (2005). Contrarian profits and the overreaction
hypothesis: The case of the Athens Stock Exchange. European Financial Management,
11, 71–98.
Atkins, A. B., & Basu, S. (1995). ‘The effect of after-hours announcements on the intraday
U-shaped volume pattern. Journal of Business Finance and Accounting, 22, 789–809.
Avramov, D., Chordia, T., & Goyal, A. (2006). The impact of trades on daily volatility.
Review of Financial Studies, 19, 1241–1277.
Baker, M., & Wurgler, J. (2006). Investor sentiment and the cross-section of stock returns.
Journal of Finance, 61, 1645–1680.
Baker, M., & Wurgler, J. (2007). Investor sentiment in the stock market. Journal of
Economic Perspectives, 21, 129–151.
Baklaci, H. F., Olgun, O., & Can, E. (2011). Noise traders: A new approach to understand the
phantom of stock markets’. Applied Economics Letters, 18, 1035–1041.
Ball, R., & Brown, P. (1968). An empirical investigation of accounting income numbers.
Journal of Accounting Research, 6, 159–178.
Barber, B. M., & Odean, T. (2001). Boys will be boys: Gender, overconfidence, and com-
mon stock investment. Quarterly Journal of Economics, 116, 261–292.
Barberis, N., Shleifer, A., & Vishny, R. (1998). A model of investor sentiment. Journal of
Financial Economics, 49, 307–343.
Barkham, R. J., & Ward, C. W. R. (1999). Investor sentiment and noise traders: Discount to
net asset value in listed property companies in the UK. Journal of Real Estate Research,
18, 291–312.
Bartov, E. (1992). Patterns in unexpected earnings as an explanation for post-earnings
announcement drift. Accounting Review, 67, 610–622.
Benartzi, S., & Thaler, R. H. (1995). Myopic loss aversion and the equity premium puzzle.
Quarterly Journal of Economics, 110, 73–92.
Bender, J. C., Osler, C. L., & Simon, D. (2013). Noise trading and illusory correlations in U.S.
equity markets. Review of Finance, 17, 625–652.
Bernard, V. (1992). Stock price reactions to earnings announcements. In R. Thaler (Ed.),
Advances in Behavioral Finance (pp. 303–340). New York: Russell Sage Foundation.
Bernard, V., & Thomas, J. (1989). Post-earnings announcement drift: Delayed price
response or risk premium? Journal of Accounting Research, 27, 1–36 (Supplement).
Bernard, V., & Thomas, J. (1990). Evidence that stock prices do not fully reflect the implica-
tions of current earnings. Journal of Accounting and Economics, 13, 305–341.
Berry, T. D., & Howe, K. M. (1994). Public information arrival. Journal of Finance, 49,
1331–1346.
Billingsley, R. S., & Chance, D. M. (1996). Benefits and limitations of diversification among
commodity trading advisors. Journal of Portfolio Management, 23, 65–80.
Black, F. (1986). Noise. Journal of Finance, 41, 529–543.
Black, F., & Scholes, M. (1973). The Pricing of options and corporate liabilities. Journal of
Political Economy, 81, 637–665.
Blair, B. J., Poon, S., & Taylor, S. J. (2001). Modeling S&P 100 volatility: The information
content of stock returns. Journal of Banking & Finance, 25, 1665–1679.
Bloomfield, R., O’Hara, M., & Saar, G. (2009). How noise trading affects markets: An exper-
imental analysis. Review of Financial Studies, 22, 2275–2302.
Blume, L., & Easley, D. (1994). Market statistics and technical analysis: The role of volume.
Journal of Finance, 49, 153–182.
Bodurtha, J., Kim, D., & Lee, C. (1995). Closed-end country funds and U.S. market sentiment.
Review of Financial Studies, 3, 879–918.
Bossaerts, P. (2009). What Decusion Neuroscince teaches financial decision making.
Annual Review of Financial Economics, 1, 383–404.
Bowman, R. (1980). The importance of a market-value measurement of debt in assessing
leverage. Journal of Accounting Research, 18, 242–254.
Brinson, G. P., Hood, R. L., & Beebower, G. L. (1986). Determinants of portfolio performance.
Financial Analysts Journal, 42, 39–44.
Brouwer, I., Van Der Put, J., & Veld, C. (1997). Contrarian INVESTMENT STRATEGIES IN A
EUROPEAN CONTEXT. Journal of Business Finance and Accounting, 24, 1353–1366.
Brown, G. W. (1999). Volatility, sentiment and noise traders. Financial Analysts Journal, 55,
82–90.
Brown, G. W., & Cliff, M. (2005). Investor sentiment and asset valuation. Journal of
Business, 35, 405–440.
Campbell, J. Y., Grossman, S. J., & Wang, J. (1993). Trading volume and serial correlation in
stock returns. Quarterly Journal of Economics, 108, 905–939.
Campbell, J. Y., Lo, A. W., & MacKinlay, A. C. (1997). The econometrics of financial markets.
Princeton: Princeton University Press.
Carhart, M. M. (1997). On persistence in mutual fund performance. Journal of Finance, 52,
57–82.
Chan, K., Hameed, A., & Tong, W. (2000). Profitability of momentum strategies in the
international equity markets. Journal of Financial and Quantitative Analysis, 35,
153–172.
Chau, F., Dosmukhambetova, G. B., & Kallinterakis, V. (2013). International financial
reporting standards and noise trading evidence from central and eastern European
countries. Journal of Applied Accounting Research, 14, 37–53.
Chen, C. R., Mohan, N. J., & Steiner, T. L. (1999). Discount rate changes, stock market
returns, volatility, and trading volume: evidence from intraday data and implications
for market efficiency. Journal of Banking & Finance, 23, 897–924.
Chen, G., Rui, O. M., & Wang, S. S. (2005). The effectiveness of price limits and stock
characteristics: Evidence from the Shanghai and Shenzhen Stock Exchanges. Review
of Quantitative Finance and Accounting, 25, 159–182.
Chin, J. Y. F., Prevost, A. K., & Gottesman, A. A. (2002). Contrarian investing in a small
capitalization market: Evidence from New Zealand. Financial Review, 37, 421–446.
Chopra, N., Lakonishok, J., & Ritter, J. R. (1992). Measuring abnormal performance: Do
stocks overreact? Journal of Financial Economics, 31, 235–268.
Chordia, T., & Shivakumar, L. (2002). Momentum, business cycle, and time-varying
expected returns. Journal of Finance, 57, 985–1019.
Chou, P. K. C., Wei, J., & Chung, H. (2007). Sources of contrarian profits in the Japanese
market. Journal of Empirical Finance, 14, 261–286.
Chui, A. C. W., & Wei, K. C. J. (1998). Book-to-market, firm size, and the turn-of-the-year
effect: Evidence from Pacific-Basin emerging markets. Pacific Basin Journal of Finance,
6, 275–293.
Connolly, R., & Stivers, C. (2003). Momentum and reversals in equity-index returns during
periods of abnormal turnover and return dispersion. Journal of Finance, 58,
1521–1556.
Copeland, T., Dolgoff, A., & Moel, A. (2004). The role of expectations in explaining the
cross-section of returns. Review of Accounting Studies, 9, 149–188.
Cordell, D. M., Smith, R., & Terry, A. (2011). Overconfidence in financial planners. Financial
Services Review, 20, 253–263.
 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100
Cutler, D. M., Poterba, J. M., & Summers, L. H. (1991). Speculative dynamics. Review of
Economic Studies, 58, 529–546.
Daniel, K., Hirshleifer, D., & Subrahmanyam, A. (1998). Investor psychology and security
market under- and overreactions. Journal of Finance, 53, 1839–1885.
Davidson, S., & Ramiah, V. (2010). Inefficiency of the Australian Stock Market. The Behavioral
Finance Handbook. Cheltenham: Edward Elgar.
De Bondt, W. F. M., & Thaler, R. H. (1985). Does stock market overreact? Journal of Finance,
60, 793–805.
De Bondt, W. F. M., & Thaler, R. H. (1995). Financial decision-making in markets and
firms: A behavioral perspective. In R. A. Jarrow, V. Maksimovic, & W. T. Ziemba
(Eds.), Handbooks in Operations Research and Management Science: Finance.
Amsterdam: Elsevier.
De Long, J. (2005). Financial markets, noise traders, and fundamental risk: Background
memo. http://citeseerx.ist.psu.edu/viewdoc/download?doi =10.1.1.186.746&rep=
rep1&type=pdf
De Long, J., Shleifer, A., Summers, L., & Waldman, J. (1990). Noise trader risk in financial
markets. Journal of Political Economy, 98, 703–738.
Deaves, R., Lüders, E., & Luo, G. (2009). An experimental test of the impact of overconfidence
and gender on trading activity. Review of Finance, 13, 555–575.
Dennis, P., & Mayhew, S. (2002). Risk-neutral skewness: Evidence from stock options.
Journal of Financial and Quantitative Analysis, 37, 471–496.
Dow, J., & Gorton, G. (1993). Trading, communication and the response of asset prices to
news. The Economic Journal, 103, 639–646.
Dow, J., & Gorton, G. (1994). Arbitrage chains. Journal of Finance, 49, 819–849.
Dreman, D., & Berry, M. (1995). Analyst forecasting errors and their implications for security
analysis. Financial Analysts Journal, 51, 30–42.
Drew, M., Naughton, T., & Veeraraghavan, M. (2003). Firm size, book-to-market equity
and security returns: Evidence from the Shanghai Stock Exchange. Australian Journal
of Management, 28, 119–139.
Duran, A., & Caginalp, G. (2007). Overreaction diamonds: Precursors and aftershocks for
significant price changes. Quantitative Finance, 7, 321–342.
Easley, D., Hvidkjaer, S., & O’Hara, M. (2002). Is information risk a determinant of asset
returns? Journal of Finance, 57, 2185–2221.
Easton, P., & Harris, T. (1991). Earnings as an explanatory variable for returns. Journal of
Accounting Research, 29, 19–36.
Edwards, W. (1968). Conservatism in human information processing. In B. Kleinmutz
(Ed.), Formal Representation of Human Judgment. New York: Wiley.
Fama, E. (1965). Random walks in stock market prices. Financial Analysts Journal, 21,
55–59.
Fama, E. (1970). Efficient capital markets: A review of theory and empirical work. Journal
of Finance, 25, 383–417.
Fama, E., & French, K. (1993). Common risk factors in the returns on stocks and bonds.
Journal of Financial Economics, 33, 3–56.
Fama, E., & French, K. (1996). Multifactor explanations of asset pricing anomalies. Journal
of Finance, 51, 55–84.
Fama, E., & French, K. (1998). Value versus growth: The international evidence. Journal of
Finance, 53, 1975–1999.
Farag, H. (2014). Investor overreaction and unobservable portfolios: Evidence from an
emerging market. Applied Financial Economics, 24, 1313–1322.
Festinger, L., Riecken, H. W., & Schachter, S. (1956). When prophecy fails. Minneapolis:
University of Minneapolis Press.
Fischer, D. (2012). Investor underreaction to earnings surprises and overreaction to
product news in the drug industry. The Journal of Business and Economic Studies,
18, 82–90.
Flannery, M. J. (1986). Asymmetric information and risky debt maturity choice. Journal of
Finance, 41, 19–39.
Forner, C., & Marhuenda, J. (2003). Contrarian and momentum strategies in the Spanish
Stock Market. European Financial Management, 9, 67–88.
Foster, F. D., & Viswanathan, S. (1990). A theory of the interday variations in volume,
variance, and trading costs in securities markets. Review of Financial Studies, 3,
593–694.
Foster, F. D., & Viswanathan, S. (1993). The effect of public information and competition
on trading volume and price volatility. Review of Financial Studies, 6, 23–56.
Frank, J. D. (1935). Some psychological determinants of the level of aspiration. American
Journal of Psychology, 47, 285–293.
Freeman, R., & Tse, S. (1989). The multiperiod information content of accounting earnings:
Confirmations and contradictions of previous earnings reports. Journal of Accounting
Research, 27, 49–79.
Frydman, C., Barberis, N., Camerer, C., Bossaerts, P., & Rangel, A. (2014). Using neural data
to test a theory of investor behavior: An application to realization theory. Journal of
Finance, 69, 907–946.
Fung, A. K. W. (1999). Overreaction in the Hong Kong Stock Market. Global Finance
Journal, 10, 223–230.
Gervais, S., Kaniel, R., & Mingelgrin, D. H. (2001). The high-volume return premium.
Journal of Finance, 56, 877–919.
Glaser, M., & Weber, M. (2007). Overconfidence and trading volume. Geneva Risk
Insurance Review, 32, 1–36.
Graham, J. R., Harvey, C. R., & Huang, H. (2009). Investor competence, trading frequency,
and home bias. Management Science, 55, 1094–1106.
Griffin, D., & Tversky, A. (1992). The weighting of evidence and determinants of confidence.
Cognitive Psychology, 24, 411–435.
Grinblatt, M., & Han, B. (2005). Prospect theory, mental accounting, and momentum.
Journal of Financial Economics, 78, 311–339.
Groenewold, N., Tang, S. H. K., & Wu, Y. (2003). The dynamic relationship between stock
returns and market turnover: Evidence from Shanghai, Shenzhen and Hong Kong.
Asia Pacific Journal of Economics and Business, 7, 18–41.
99
Hameed, A., & Kusnadi, Y. (2002). Momentum strategies: Evidence from Pacific Basin
Stock Markets. Journal of Financial Research, 25, 383–397.
Hameed, A., & Ting, S. (2000). Trading volume and short-horizon contrarian profits:
Evidence from the Malaysian Market. Pacific-Basin Finance Journal, 8, 67–84.
Harrison, G. W., & Rutstrom, E. E. (2009). Expected utility theory and prospect theory:
One wedding and a decent funeral. Experimental Economics, 12, 133–158.
Haugen, R. (1999). The inefficient stock market. Upper Saddle River (NJ): Prentice Hall.
Holt, C. A., & Laury, S. K. (2002). Risk aversion and incentive effects. American Economic
Review, 92, 1644–1655.
Hong, H., Lim, T., & Stein, J. (2000). 'Bad news travels slowly: Size, analyst coverage, and
the profitability of momentum strategies. Journal of Finance, 55, 265–295.
Hu, C., & Wang, Y. (2013). Noise trading and stock returns: Evidence from China’. China
Finance Review International, 3, 301–315.
Jegadeesh, N., & Titman, S. (1993). Returns to buying winners and selling losers: Implications
for stock market efficiency. Journal of Finance, 48, 65–91.
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Management behavior,
agency costs and ownership structure. Journal of Financial Economics, 3, 305–360.
Kahneman, D., Knetsch, J. L., & Thaler, R. H. (1990). Experimental tests of the endowment
effect and the coase theorem. Journal of Political Economy, 98, 1325–1348.
Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decisions under risk.
Econometrica, 47(2), 313–327.
Kang, J., Liu, M., & Ni, S. X. (2002). Contrarian and momentum strategies in the China
Stock Market: 1993-2000. Pacific-Basin Finance Journal, 10, 243–265.
Kavajecz, K. A., & Odders-White, E. R. (2004). Technical analysis and liquidity provision.
Review of Financial Studies, 17, 1043–1071.
Kittiakarasakun, J., Tse, Y., & Wang, G. H. K. (2012). The impact of trades by traders on
asymmetric volatility for Nasdaq-100 Index Futures. Managerial Finance, 38, 752–767.
Kyle, A. (1985). Continuous auction and insider trading. Econometrica, 53, 1315–1336.
Lakonishok, J., Shleifer, A., & Vishny, R. (1994). Contrarian investment, extrapolation, and
risk. Journal of Finance, 49, 1541–1578.
Lee, W. Y., Jiang, C. X., & Indro, D. C. (2002). Stock market volatility, excess returns, and the
role of investor sentiment. Journal of Banking & Finance, 26, 2277–2299.
Lee, M. C., Shleifer, A., & Thaler, R. H. (1991). Investor sentiment and the close-end fund
puzzle. Journal of Finance, 46, 75–109.
Lee, C. M. C., & Swaminathan, B. (2000). Price momentum and trading volume. Journal of
Finance, 55, 2017–2069.
Lemmon, M., & Portniaguina, E. (2006). Consumer confidence and asset prices: Some
empirical evidence. Review of Financial Studies, 19, 1499–1529.
Lintner, J. (1965). The Valuation of risk assets and the selection of risky investments
in stock portfolios and capital budgets. The Review of Economics and Statistics, 47,
13–37.
Lo, K., & Coggins, R. (2006). Effects of order flow imbalance on short-horizon contrarian
strategies in the Australian Equity Market. Pacific-Basin Finance Journal, 14, 291–310.
Lo, A. W., & MacKinlay, A. C. (1990). When are contrarian profits due to stock market
overeaction? Review of Financial Studies, 3, 175–206.
Lobe, S., & Rieks, J. (2011). Short-term market overreaction on the Frankfurt Stock
Exchange. The Quarterly Review of Economics and Finance, 51, 113–123.
Low, C. (2004). The fear and exuberance from implied volatility of S&P 100 Index Options.
Journal of Business, 77, 527–546.
Markowitz, H. M. (1952). Portfolio selection. Journal of Finance, 7, 77–91.
Mendenhall, R. R. (1991). Evidence on the possible underweighting of earnings-related
information. Journal of Accounting Research, 29, 170–179.
Menkhoff, L., & Schmidt, U. (2005). The use of trading strategies by fund managers: Some
first survey evidence. Applied Economics, 37, 1719–1730.
Miller, M. E. (1977). Risk, uncertainty, and divergence of opinion. Journal of Finance, 32,
1151–1172.
Modigliani, F. (1982). Debt, dividend policy, taxes, inflation and market valuation. Journal
of Finance, 37, 255–275.
Modigliani, F., & Miller, M. (1958). The cost of capital, corporation finance and the theory
of investment. American Economic Review, 48, 261–297.
Modigliani, F., & Miller, M. (1963). Corporate income taxes and the cost of capital: A
correction. American Economic Review, 53, 433–443.
Moosa, I. A. (2013). The Capital Asset Pricing Model (CAPM): The history of a failed
revolutionary idea in finance? Comments and extensions. Abacus, 49, 62–68.
Moosa, I. A. (2015). The regulation of high-frequency trading: A pragmatic view. Journal of
Banking Regulation (in press).
Moosa, I. A., & Ramiah, V. (2015). The efficient market hypothesis: A cause or a casualty of
the global financial crisis? RMIT, Working Paper.
Muller, M. G., & Pfnuer, A. (2013). A review of the noise trader model concerning the NAV
spread in REIT pricing: Evidence from the Pan EU REIT Market. Journal of Real Estate
Portfolio Management, 19, 189–205.
Mun, J. C., Vasconcellos, G. M., & Kish, R. (1999). Tests of the contrarian investment
strategy: Evidence from the French and German Stock Markets. International
Review of Financial Analysis, 8, 215–234.
Myers, S. C. (1977). Determinants of corporate borrowing. Journal of Financial Economics,
5, 147–175.
Myers, S. C. (1984). The capital structure puzzle. Journal of Finance, 39, 575–592.
Myers, S. C., & Majluf, N. S. (1984). Corporate financing and investment decisions when
firms have information that investors do not have. Journal of Financial Economics,
13, 187–221.
Narayanamoorthy, G. (2006). Conservatism and cross-sectional variation in post-earnings
announcement drift. Journal of Accounting Research, 44, 763–787.
Nguyen, D., & Daigler, R. (2006). A return-volume-volatility analysis of futures contracts.
Review of Futures Markets, 15, 265–293.
Novak, J., & Hamberg, M. (2005). Contrarian investment, accounting conservatism and
transitory earnings. Journal of Financial Economics, 43, 3–27.
100 V. Ramiah et al. / International Review of Financial Analysis 41 (2015) 89–100
Odean, T. (1998a). Are investors reluctant to realize their losses? Journal of Finance, 54,
1775–1798.
Odean, T. (1998b). Volume, volatility, price, and profit when all traders are above average.
Journal of Finance, 53, 1887–1934.
Osler, C. (1998). Identifying noise traders: The head-and-shoulders pattern in U.S. Equities,
Staff Report No.42, Federal Reserve Bank of New York.
Otchere, I., & Chan, J. (2003). Short-term overreaction in the Hong Kong Stock Market:
Can a contrarian trading strategy beat the market? Journal of Behavioural Finance, 4,
157–171.
Pagano, M., & Roell, A. (1996). Transparency and liquidity: A comparison of auction and
dealer markets with informed trading. Journal of Finance, 51, 579–611.
Park, C., & Irwin, S. H. (2007). What do we know about the profitability of technical analysis.
Journal of Economic Surveys, 21, 786–826.
Penman, S. H. (1987). The distribution of earnings news over time and seasonalities in
aggregate stock returns. Journal of Financial Economics, 18, 199–228.
Pratt, J. W. (1964). Risk aversion in the small and the large. Econometrica, 32, 122–136.
Pritamani, M., & Singal, V. (2001). Return predictability following large price changes and
information releases. Journal of Banking & Finance, 25, 631–656.
Qiu, X. L., & Welch, I. (2004). Investor sentiment measures. Working Paper. Brown
University.
Ramiah, V., Cheng, K. Y., Orriols, J., Naughton, T., & Hallahan, T. (2011a). Contrarian
investment strategies work better for dually-traded stocks: Hong Kong Evidence.
Pacific-Basin Finance Journal, 19, 140–156.
Ramiah, V., & Davidson, S. (2007). An information-adjusted noise model: Evidence of
inefficiency on the Australian Stock Market. Journal of Behavioural Finance, 8,
209–224.
Ramiah, V., Mugwagwa, T., & Naughton, T. (2011b). Hot and cold strategies: Australian
Evidence. Review of Pacific Basin Financial Markets and Policies, 14, 1–25.
Rendleman, R. J., Jones, C. P., & Latane, H. A. (1982). Empirical anomalies based on earnings.
Journal of Financial Economics, 35, 269–287.
Rouwenhorst, K. G. (1998). International momentum strategies. Journal of Finance, 53,
267–284.
Rouwenhorst, K. G. (1999). Local return factors and turnover in emerging stock markets.
Journal of Finance, 54, 1439–1464.
Ryan, S. (1997). A survey of research relating accounting numbers to systematic equity
risk, with implications for risk disclosure policy and future research. Accounting
Horizons, 11, 82–95.
Samuelson, W., & Zechauser, R. (1988). Status quo bias in decision making. Journal of Risk
and Uncertainty, 1, 7–59.
Selden, G. C. (1912). Psychology of the stock market: Human impulses lead to speculative
disasters. New York: Ticker Publishing.
Sharpe, W. F. (1964). Capital asset prices: A theory of market equilibrium under condi-
tions of risk. Journal of Finance, 19, 425–442.
Shefrin, H., & Statman, M. (1994). Behavioral capital asset pricing theory. Journal of
Financial and Quantitative Analysis, 29, 323–349.
Shiller, R. J. (1981). Do stock prices move too much to be justified by subsequent changes
in dividends? American Economic Review, 71, 421–436.
Shleifer, A., & Summers, L. H. (1990). The noise trader approach to finance. Journal of
Economic Perspectives, 4, 19–33.
Sias, R., Starks, L. T., & Tinic, S. (2001). Is noise trader risk priced? Journal of Financial
Research, 24, 311–329.
View publication stats
Song, A., Tan, H., & Wu, Y. (2005). Trade size, trade frequency, and the volatility-volume
relation. Journal of Risk Finance, 6, 424–437.
Statman, M. (November/December 1999). Behaviorial finance: Past battles and future
engagements. Financial Analysts Journal, 18–27.
Statman, M., Thorley, S., & Vorkink, K. (2006). Investor overconfidence and trading
volume. Review of Financial Studies, 19, 1531–1565.
Sturm, R. R. (2013). Market efficiency and technical analysis: Can they coexist? Research
in Applied Economics, 5, 1–16.
Subrahmanyam, A. (2010). The cross-section of expected stock returns: What have we
learnt from the past twenty-five years of research? European Financial Management,
16, 27–42.
Taylor, S., & Brown, J. (1988). Illusion and wellbeing: A social psychology perspective on
mental health. Psychological Bulletin, 103, 193–210.
Tetlock, P. C. (2006). Does noise trading affect securities market efficiency? Woeking Paper
http://www.columbia.edu/~pt2238/papers/Tetlock_Noise_and_Efficiency_09_06.pdf
Thaler, R. H. (1980). Toward a positive theory of consumer choice. Journal of Economic
Behavior and Organization, 1, 39–60.
Tversky, A., & Kahneman, D. (1973). Availability: A heuristic for judging frequency and
probability. Cognitive Psychology, 5, 207–232.
Tversky, A., & Kahneman, D. (1974). Judgment under uncertainty: Heuristics and biases.
Science, 185 (453-1124-1131).
Tversky, A., & Kahneman, D. (1981). The framing of decisions and the psychology of
choice. Science, 211, 453–458.
Uygur, U., & Taş, O. (2014). The impacts of investor sentiment on returns and conditional
volatility of international stock markets. Quality and Quantity: International Journal of
Methodology, 48, 1165–1179.
Vachadze, G. (2001). Recovery of hidden information from stock price data. Journal of
Economics and Finance, 25, 243–258.
Verma, R., & Verma, P. (2006). Noise trading and stock market volatility. Journal of
Multinational Financial Management, 17, 231–243.
Vora, P. P., & McGinnis, J. D. (2000). The asset allocation decision in retirement: Lessons
from dollar-cost averaging. Journal of Financial Services Review, 9, 47–63.
Wang, Y., Li, C., & Lin, C. (2009). The impact of investor sentiment on the futures market:
Evidence from the Taiwan Futures Exchange. International Research Journal of Finance
and Economics, 28, 134–151.
Wiggins, J. S. (1991). Agency and communion as conceptual coordinates for the under-
standing and measurement of interpersonal behavior. In W. M. Grove, & D. Ciccetti
(Eds.), Thinking Clearly about Psychology (Volume 2): Personality and Psychopathology.
Minneapolis (MN): University of Minnesota Press.
Xu, X., Ramiah, V., Moosa, I. A., & Davidson, S. (2015). An application of the information-
adjusted noise model to the Shenzhen Stock Market. International Journal of
Managerial Finance (in press).
Yaari, M. E. (1987). The dual theory of choice under risk. Econometrica, 55, 95–115.
Yang-Tzong, T., Alt, F., & Gordon, L. A. (1993). The capital market reaction to announced
deep cut in expenditure. Managerial and Decision Economics, 14, 1–14.
Yoshio, L., Hideaki-Kiyoshi, K., & Toshifumi, T. (2004). The winner-loser effect in Japanese
Stock Returns. Japan and the World Economy, 16, 471–485.
You, H., & Zhang, X. (2011). Limited attention and stock price drift following earnings
announcements and 10-K Filings. China Finance Review International, 1, 358–387.