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Noise Bubbles

Authors


  • Mario Forni gratefully acknowledges the contribution of the MIUR for the PRIN project 2010J3LZEN_003. Luca Gambetti gratefully ackowledges the financial support from the Spanish Ministry of Economy and Competitiveness through grant ECO2012-32392 and the Barcelona Graduate School Research Network.

Abstract

We introduce imperfect information in stock prices determination. Agents, whose expectations are not assumed to be rational, receive a noisy signal about the structural shock driving future dividend variations. Equilibrium stock prices are decomposed into a fundamental component and a transitory ‘noise bubble’ which can be responsible for boom and bust episodes unrelated to economic fundamentals. We propose a non-standard VAR procedure to estimate the effects of noise shocks as well as bubble episodes. Noise explains a large fraction of US stock prices. In particular the dot-com bubble is almost entirely explained by noise.

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