Noise Trader Essay

908 Words 4 Pages
2. Noise trader risk
Noise trader risk refers to the risk that the mispricing worsens in the short run because there is possibility that pessimistic traders become even more pessimistic about the future. Once a position is taken, noise traders may drive prices farther from fundamental value, and the arbitrageur may be forced to invest additional capital, which may not be available, forcing an early liquidation of the position.

3. Information gap and financing issues
Generally, the arbitrageurs are informed but wealth constrained and the investors are uninformed and wealthy. In a situation where noise trader risk rises and the mispricing worsens and the fund has to pay lot of margin calls to hold the position, the investors may panic and the
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It should not be misunderstood that market efficiency implies market price equals to intrinsic values at every point of time. All that it says is that the errors in market price are unbiased. This implies that price can deviate from intrinsic values but the deviations are random and uncorrelated with any observable variable. If the deviations of the market price from intrinsic value are random, it is not possible to constantly identify over or undervalued security. Market efficiency is defined in relation to information that is reflected in security prices. Basing on this Eugene Fama had suggested the three level of market efficiency i.e. Weak Form, Semi-Strong Form and Strong Form of efficiency. Hence, according Eugene Fama it is impossible to beat the market because prices already incorporate and reflect all relevant …show more content…
Their argument against the efficient market theory is that many investors based their expectations on past prices, past earnings, track records and other indicators. Because stock prices are largely based on investor’s expectations, many believe it; only make sense to believe that prices influences future prices. Meanwhile, academics point to a large body of evidence in support of EMH, an equal amount of dissension also exists. For example investors such as Warren Buffett have consistently beaten the market over long period of time, which by definition is impossibility according to EMH. Detractors of EMH also point to events such as 1987 stock crash (when the DJIA fell by over 20% in a single day) as evidence that stock prices can seriously deviate from their fair. The research will focus on evidencing how far the Indian equity derivative market that is the index futures and index options is efficient and whether investors can use it as a tool for making profit or it could be a tool for hedging only. This research would also focus on the factors which influences the cash market segment as a result of trading on equity

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