TY  - JOUR
AU  - Dow, James
AU  - Gorton, Gary
TI  - Noise Trading, Delegated Portfolio Management, and Economic Welfare
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 4858
PY  - 1994
Y2  - September 1994
DO  - 10.3386/w4858
UR  - http://www.nber.org/papers/w4858
L1  - http://www.nber.org/papers/w4858.pdf
N1  - Author contact info:
James Dow
London Business School
Sussex Place
Regent's Park, London
NW1 4SA  UK
Tel: 4402072625050 Ext3317
Fax: 4402077243317
E-Mail: jdow@london.edu

Gary B. Gorton
Yale School of Management
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
Fax: 203/432-8931
E-Mail: Gary.Gorton@yale.edu
AB  - We consider a model of the stock market with delegated portfolio management.  All agents are rational: some trade for hedging reasons, some investors optimally contract with portfolio managers who may have stock-picking abilities, and portfolio managers trade optimally given the incentives provided by this contract.  Managers try, but sometimes fail, to discover profitable trading opportunities.  Although it is best not to trade in this case, their clients cannot distinguish 'actively doing nothing,' in this sense, from 'simply doing nothing.' Because of this problem: (i) some portfolio managers trade even though they have no reason to prefer one asset to another (noise trade).  We also show that, (ii), the amount of such noise trade can be large compared to the amount of hedging volume.  Perhaps surprisingly, (iii), noise trade may be Pareto-improving.  Noise trade may be viewed as a public good.  Results (i) and (ii) are compatible with observed high levels of turnover in securities markets.  Result (iii) illustrates some of the possible subtleties of the welfare economics of financial markets.
ER  -