Working Paper: CEPR ID: DP9532
Authors: Mario Forni; Luca Gambetti; Marco Lippi; Luca Sala
Abstract: We introduce noisy information into a standard present value stock price model. Agents receive a noisy signal about the structural shock driving future dividend variations. The resulting equilibrium stock price includes a transitory component ? the "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 structural shock and the "noise" shock, their impulse response functions and the bubble component of stock prices. We apply such procedure to US data and find that noise explains a large fraction of stock price volatility. In particular the dot-com bubble is entirely explained by noise. On the contrary the stock price boom peaking in 2007 is not a bubble, whereas the following stock market crisis is largely due to negative noise shocks.
Keywords: Noise shocks; Rational bubbles; Structural VARs
JEL Codes: C32; E32; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| noise shocks (R41) | stock price volatility (G17) |
| noise shocks (R41) | stock prices (G12) |
| dividend shock (G35) | long-term fluctuations in stock prices (E32) |
| noise bubbles (E32) | stock prices (G12) |
| noise shocks (R41) | transitory boom and bust episodes (E32) |