"Noise Trader Risk" & "Fundamental Risk"

CFA Level III
#1

These terms are used in a statement on page 91, and then used in question 2 on the following page (CFAI VOL II). For the life of me, I cannot find either of these terms used earlier in readings, nor are they listed in the glossary or index. Can someone please point out to me where these two terms come from?

#2

bump. Sorry but this is really driving me nuts can someone point me here?

#3

These terms are from a 2008 reading called A Survey of Behavorial Finance. It’s not part of 2009 readings.

#4

… so guaranteed to be on the exam…

#5

I think noise trader risk is trading based off emotions without evaluating the fundamentals.

#6

PhillyBanker Wrote: ------------------------------------------------------- > I think noise trader risk is trading based off > emotions without evaluating the fundamentals. Sounds right, and doesn’t this have to do with why identifying market inefficiencies (chronic, I think) doesn’t work out sometimes? The noise trading drives the asset price versus fundamentals?

#7

LOL…had me in a bit of a panic there. I knew I recognized those terms, but don’t have anything in my notes on them. I remember them from last year. From my CFA books last year Noise Trader Risk - Irrational traders are known as “noise traders.” The risk is that the mispricing being exploited by the arbitrageur worsens in the short run. Usually refering to a long short strategy. Noise trader risk matters because it can force arbitrageurs to liquidate their positions early, bringing them potentially steep losses. Fundamental Risk - most obvious risk an arbitrageur faces is if they buy a stock and a piece of bad news about that stocks fundamental value comes out causing the stock value to fall leading to losses.

#8

BB, thanks, but as the other guy mentioned, can anyone find these terms in the 2009 materials other than in that one question I cited? I think the earlier poster is right, they may have been included errantly.

#9

Nope…they are part of that Survey of Behavioural Analysis reading that is not in the material this year. So, we aren’t responsible for them this year.

#10

thanks guys, I appreciate the clarification.

#11

Just know that in general an investor will face both fundamental risk and noise trader risk. If an investor executes a market nuetral strategy – pairs trading – an investor can eliminate fundamental risk (assuming availability of “perfect” substitutes). Noise trader risk will always be there – it is exacerbated during crisis period as can be seen in real life since July 2007. Not sure, but I think noise trader risk can be termed as a chronic inefficiency.