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Noise Trading and Abnormal Return in Stock Market

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Revista Argentina de Clínica Psicológica 317 2020, Vol. XXIX, N°4, 317-324 DOI: 10.24205/03276716.2020.831 Noise Trading and Abnormal Return in Stock Market Chiu-Lan Changa, Ming Fangb* Abstract This study analyzes the relationship between noise trading and abnormal returns on assets. This study first validates the positive correlation between noise trading and abnormal returns on assets. In markets with high noise trading, the higher the abnormal returns on its assets, and vice versa. In exploring the relationship between noise trading and asset yield, this study uses abnormal return as a new indicator proposed in recent years for analysis. When analyzing the impact of company fundamentals on return on assets, the variables of company fundamentals are integrated using clustering analysis and principal component analysis. This suggests that in the long run there is a mutual causal relationship between noise trading and abnormal returns on assets. The results of this study show that the deviation from the interaction of noise trades and abnormal returns can be corrected and reach the equilibrium in the long run. Keywords: noise trade, abnormal return, long-term equilibrium relationship, causal relationship. 1. Introduction In analyzing the impact of the company's Noise trading research is an important research fundamentals on the return on assets, the financial in behavioral finance. Scholars have carried out indicators reflecting the fundamentals of the research and discussion on the influence of noise securities and applied with clustering analysis and trading and related problems such as noise trading principal component analysis. measurement indicators. In recent years, with the vigorous development 2. Literature Review of China's financial market, more and more scholars Noise traders are defined as investors who do not based on China's special policy restrictions on have access to inside information, irrationality, use China's capital market noise trading related research error messages or even information as correct and empirical analysis. information and trade on that basis (De Long et al, 1989, De Long et al, 1990). Therefore, the noise of the This study explores the relationship between capital market also mainly refers to the above- noise trading and excess return on assets. This study mentioned investors as the basic role of transaction not only uses new indicators developed in recent years, but also uses newer research methods. In the decision-making, but not related to the capital market-related products in the capital market specific exploration of the relationship between relevance or incorrect information. noise trading and asset returns, this study uses excess yield, a new indicator proposed in recent In fact, how to measure noise and how to select the measure of noise trading has always been an years, for analysis. important topic in behavioral finance. aProfessor, Department of Finance, Fuzhou University of Some literatures categorize the investors into International Studies and Trade, China *bAssociate Professor, Department of Finance, Fuzhou University of two types which are rational investors and noise International Studies and Trade, China traders. The rational investors have rational *Corresponding Author: Ming Fang expectations about security returns and noise traders Email: [email protected] trades according to their sentiment. Both types of investors trade in the market depending on their own beliefs. Therefore, the trading behaviors may be very different. However, most of the investors are REVISTA ARGENTINA 2020, Vol. XXIX, N°4, 317-324 DE CLÍNICA PSICOLÓGICA 318 Chiu-Lan Chang, Ming Fang* avoiding risks. Previous researches consider the market values. Meanwhile, the return of rational individual investors are noise traders and the investors comes from the losses of irrational institutional investors are rational investors. Because investors. If the irrational traders continue to lose institutional traders generally mine information and money, they will gradually exit the market or become are relatively knowledgeable about the information; rational investors. Therefore, under the efficient while individual investors cannot dig deep into market hypothesis, irrational noise traders cannot be effective information due to financial, material, and squeezed out of the trading market for long periods manpower constraints, and even trade based on of time due to the natural selection of the market and gossip, so the researchers believe that noise trading the arbitrage behavior of rational and informed Generally speaking, they are individual investors. traders. However, practically it is difficult to ensure that all The efficient market hypothesis remains traders are completely rational. Some institutional controversial after the amendment. Opponents investors may be irrational investors sometimes and have questioned the efficient market hypothesis trade with a strong noise (De Long et al, 1988, from previous references to final conclusions. First Hirshleifer and Luo, 2001). of all, noise trading is widely present in the market Some researches use the quantitative methods to and does not correspond to the small number of defined the noise trading. There is no consensus in presences expressed in the hypothesis (Lee et al, academia on how to quantify noise trading. In 1991, Baker and Stein, 2004). Second, investors have general, the metrics are divided into two broad a high probability of expected the same preference categories: cross-disciplinary psychological indicators for choice, which is statistically significantly different and directly related financial transaction indicators. from the objective probability in the expected utility Among them, the psychological substitution index is (Tversky and Kahnemand, 1974). Third, in an mainly confidence index, business climate index, etc. environment of information asymmetry, investor Financial trading indicators, on the other hand, focus sentiment interacts with each other, rather than as on liquidity-related indicators, including the rate of stated in the hypothesis that irrational investors' signature, the growth rate of new account openings, investment decisions are independent of each other. the turnover rate, etc. First, scholars proposed the Finally, due to the mutual influence of investor use of liquidity, information and trading frequency to sentiment, coupled with the problem of principal distinguish between informed traders, unsuspecting agent and the shortage of arbitrage assets, arbitrage traders and market makers of the EKOP model, and does not have the ability to completely eliminate built a framework for calculating the probability of pricing errors caused by irrational behavior. informed trading (Easley,1996). Dynamic volatility Specifically: First, the issue of proxy, in the fund index is another measurement of noise trader risk managers and other found that the capital market and proves that the turnover rate is currently a better asset pricing errors and arbitrage activities, because standard for reflecting noise trading. (Ramiah, 2003). the reverse forces in the market is more powerful, The related research on noise trading focuses on the fund managers manage the net asset value of the existence of noise trading and the influence of the fund is likely to have a larger drawdown or even noise trading on the effectiveness of capital markets. reach the warning line situation. Fund managers From the efficient market hypothesis (EMH), the cannot reverse this mispricing, whether based on existence of noise trading noise trading does exist in fund contract rules or under pressure from fund a short period of time and later on the market will investors. Second, it is also likely that the average become rational (Fama, 1970). The EMH believes free-trader will be unable to prevent mispricing and that the vast majority of traders in capital markets generate large losses because the amount of assets are rational. These people have all the information cannot compete with the amount of assets of the they have and can make accurate judgments about reverse forces in the market. Based on these two the value and price of assets based on the considerations, most arbitrage traders choose to information. The revised efficient market hypothesis trade in the same way as noise traders in order to acknowledges that there are indeed a small number obtain positive returns. And since the arbitrage will of irrational people in the market who trade in a way operate later than the noise trader, the noise trader that causes a deviation in the instinct value of the will not be squeezed out of the market. The other asset. The modified efficient market hypothesis researches suggest that the return of assets to their states that assuming arbitrage is risk-free, rational instinct value is a long process. It is difficult for investors will quickly adjust their portfolios to the fair anyone who continuously lose money can still REVISTA ARGENTINA 2020, Vol. XXIX, N°4, 317-324 DE CLÍNICA PSICOLÓGICA 319 Chiu-Lan Chang, Ming Fang* restrain the anxiety of the state of mind and point collection is the direction vector sequence, maintain the original rational judgment. Therefore, where the vector is the direction of the line that best rational investors cannot completely eliminate fits the data and mates with the first vector. The core noise. In addition, Chinese and foreign scholars have of PCA is to find out a number of "common tested the effectiveness of different markets, information"
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