Do Noise Traders 'Create Their Own Space'?

We analyze myopic-trader models of noisy prices in financial markets. Unlike extant analysis, such as De Long et al. (1990a), a classical equilibrium exists in our analysis, e.g., a riskless perpetuity is priced by arbitrage and it's price does not vary with noise. Only when (a) noise traders' beliefs are rational regarding volatility and irrational regarding expected returns, and (b) noise traders may hold infinite positions, does a unique noisy equilibrium exist. In the absence of these strong assumptions, multiple noisy equilibria may coexist with the classical equilibrium, but these equilibria exhibit conflicting comparative statics. Furthermore, the price of a long-lived asset with risky cash flows may vary with noise even when investors are not myopic. One conclusion is that myopia is neither a necessary nor a sufficient condition for noisy prices. A second is that it is difficult, if not impossible, to use myopic-trader models to derive implications for investment or regulatory policy