Impact of noise traders

Noise traders not only affect the price by driving it away from fundamentals, but also by their influence on the liquidity aspect, write Violet U.T. Lei and Simon M.S. So of the University of Macau in a research paper titled Investor Sentiment and Trading Volume (www.ssrn.com). Investigating trading volume, as a proxy for liquidity, the authors note that noise traders may have effect on return.

In contrast to monthly data used as ‘sentiment proxies' by other researchers, the measure used by the authors is volatility index (VIX), obtained from the Chicago Board Options Exchange (www.cboe.com). Since noise traders are usually overconfident and over-optimistic, they can be more aggressive than rational investors, the paper observes. They therefore play an important role in the financial market. While “the unpredictability of noise traders' belief can create systematic risk and place limit to arbitrage,” and “arbitrageurs may not be willing to compete with noise traders,” a positive insight highlighted in the paper is of Black (1986) that noise makes financial markets possible and that if there is no noise trading, there will be little trading in individual assets. The authors report that change in VIX significantly explains percentage change in trading volume, but the effect only exists in high sentiment period. “The positive coefficient of change in VIX means that when VIX increases, trading volume also increases … When the level of VIX during successive trading days is higher, the variability of trading volume during the same period is also higher.”

Recommended read to decode the ‘noise' in trading.

Many investment biases are ‘human'

Investment biases are partly genetic, and such biases are not significantly moderated by education, say Henrik Cronqvist and Stephan Siegel in Why do individuals exhibit investment biases? (www.ssrn.com).

The paper begins by listing a few of the investment biases that individuals exhibit; such as reluctance to realise losses, trading too much, extrapolating recent superior performance, being insufficiently diversified, having a preference for skewness and lottery-type stocks. The authors ask whether we are born with these biases, or we exhibit them as a result of our upbringing, learning or environmental experiences.

Studying dataset from “the world's largest twin registry, the Sweden Twin Registry, matched with very detailed data on the twins' investment behaviours,” the authors decompose differences across individuals into genetic versus environmental components. They find that many investment biases are “human” in the sense that we are born with them. “We base this conclusion on empirical evidence that genetic factors explain up to 50 per cent of the variation in these biases across individuals,” the authors report.

The second finding is the absence of any evidence that education is a significant moderator of genetic investment behaviour. And the final finding is that genetic effects on investment behaviour are correlated with genetic effects on behaviours in other domains, suggesting that genetic investment bias is only one facet of the much broader individual behaviour.A topic worth investigating in different geographies.

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