Name: Instructor: Subject: Date: Different facets of the Macro Economy Question one Which one of the following are essential elements of models in which noise traders’ important effects on equilibrium assets prices despite the presence of rational arbitrageurs?…
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There was a development of model of trader risk that insinuated that decisions on investments are done with reference to market noise, and these decisions are not rational and hence unpredictable from the simple fact that they are affected by the sentiments of an investor. This makes the idiot traders a threat in markets of finance. Secondly, noise existence provides opportunists with information that enables them to exploit and take advantage of the situation in the market. These opportunists may engage in strategies of stealth trading where these investors extend their trade with time. Lastly, the irrationality by the noisy traders may lead to movement of assets’ prices from their basic values hence making the market to destabilize. Contrary to that, investors who are rational would act in a manner opposing a noisy trader hence stabilizes the market equilibrium. There is a prediction that institutional investors fail in encountering activities that are irrational by the noisy traders. The examination of the essential effects of the noisy traders on ADR market is as explained. ADR return falls or increases if the investors are not rationally pessimistic or optimistic. In the period of low noise, ADRs that are owned by high institutions exhibit autocorrelation that is same to ADRs being owned by low institutions. Nevertheless, in periods of high noise, ADRs that are owned by high institutions exhibit autocorrelation that is higher compared to the ones owned by low institutions. This creates an implication that there must have been an engagement in stealth trading by investors for exploitation of an irrational market. Via a regression of Granger causality, there is evidence of ADR portfolio returns with high institutions ownership which confirms that these traders make a reflection of the market information which is in the long run converted to securities. Finally, investors of an institution aid in the reduction of ADR returns of Europe. Though, for other continents ADRs, the stabilizing magnitude of positions of arbitrage that is taken by investors of an institution is not significant (De Long et al. 1990) Question two Consider a model with both noisy traders and rational arbitragers. Suppose there are no limits of arbitrage. Then arise in investment sentiments among the noisy traders: a) Shifts the asset demand curve of the noisy traders N b) May lead to increased short sales Y c) Has no effect on the equilibrium asset price N d) Affects the distribution of assets holding between the two groups of investors Y e) Affect the total gross supply of the assets in the market Y Discussion In case of existence of the noisy trader and an arbitrager in a market, given that there are no limits of arbitrage and a situation of arising of sentiments, a) there would not be shifts in the demand curve of the noisy traders. The explanation for this is straightforward because given an irrational trader who takes risk which give rise to investment sentiment; the prices of assets are mainly affected. In economics, the price of commodities affects demand in that the increase or decrease in prices leads to a movement of the curve and not a shift. Therefore, the statement of demand shifting is wrong as the main factor influencing demand of asset in this case is the price. b) The action may lead to increased short sales in that, in any case the noisy trader tries to sell the assets at prices that are lower than the market’
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