Noise Bubbles

Recognition Program

Authors: Mario Forni, Luca Gambetti, Luca Sala and

Economic Journal, Vol. 127, No 604, 1940-1976, September, 2017

We introduce imperfect information in stock prices determination. Agents, whose expectations are not assumed to be rational, receive a noisy signal about the structural shock driving future dividend variations. Equilibrium stock prices are decomposed into a fundamental component and a transitory '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 effects of noise shocks as well as bubble episodes. Noise explains a large fraction of US stock prices. In particular the dot-com bubble is almost entirely explained by noise.

This paper is acknowledged by the Barcelona School of Economics Recognition Program