Dynamics of Noise Traders’ Risk in the NSE and BSE Markets.

In the literature of Financial Economics, the connotation “noise” and “noise traders” play critical roles in stocks’ equilibrium pricing mechanism. The equilibrium prices, however, include economic and non-economic aspects. In an empirical exploration, the paper seeks to explore the nature and magnitude of the noise traders’ risk in the Indian markets specifically during its present recovery phase. Besides the daily trading data for “open”, “high”, “low”, and “close” prices, and corresponding trading volumes, the study utilizes the intra-day 1D (one minute) and also 5D (five minutes) trade-prices, trade-volumes, and trade-times data of the sample firms (mostly the Nifty-Fifty firms) listed both in the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The study utilizes the NSE-Nifty and the BSE-Sensex indices for the market return data. The study examines two important critical facets in Behavioral Finance – (i) whether stocks’ total return variations incorporate noise traders’ risk or not, that is, whether noise is priced in the stock markets’ equilibrium pricing mechanism or not, and (ii) whether informed traders’ short-run risky arbitrage positioning forces them to long-short positioning for possible hedging opportunities or not. The study methodologically argues that the noise as opposed to information has both systematic and firm-specific components and it varies over time while each component includes fundamental (that is, idiosyncratic) and noise aspects. At some days’ lag-periods, long-short position by traders over the two stock markets can hedge the fundamental systematic and the fundamental firm-specific shocks and may detach the noise shocks. Once stocks are traded at long or short horizons in the markets, traders’ long-short returns expose noise aspects across stocks in the markets. On the context of current recovering markets, the study explores comparisons of the results with the current price-volume-trade time data with those of two years earlier. The findings suggest that the intra-day returns (derived from 1D and 5D data) impound a significant level of noise while the daily return (weekly) returns have high (moderate) exposures to noise. The findings of conditional volatilities of long-short returns from the GARCH models show that the estimate of time-varying idiosyncratic noise is highly persistent at presence of noise traders in the equilibrium pricing mechanism. The study concludes that stocks’ prices impound information as well as noise in the market places during the four distinct trading days.