Noise Bubbles

• Authors: Mario Forni, Luca Sala and Luca Gambetti.
• Economic Journal
• Vol. 127 , No 604 ,1940-1976, April, 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.