Opening Noise in the Indian Stock Market: Analysis at Individual Stock Level

Abstract

This is an econometric study of noise in the financial markets, based on the Indian stock market. Historically, the role & impact of noise traders in the financial markets has been assumed to be minimal or negligible since noise traders should lose money when trading against rational arbitrageurs. However, Shiller et al. [1] argue that there is little reason to believe that noise traders are unimportant and some reason to suspect that rational arbitrageurs dominate the financial markets. Moreover, De Long et al. [2] have developed formal models that allow for the survival of noise traders. Like any other systematic risk, the risk brought in by the noise traders, due to their random sentiments, should be priced. In this paper, we propose an “opening noise trading model” in which the opening price of the stock contains a component of noise that is assumed to be orthogonal to the true price change caused by the arrival of new information. We also provide evidence of the opening stock price containing noise on an everyday basis among all the Nifty stocks. Furthermore, we have shown how to estimate the share of noise in the opening price.