Can Noise Traders Survive? Evidence from Closed-End Funds

This study presents the results of the first direct empirical tests of the De Long, Schleifer, Summers, and Waldmann noise trader model. The two key propositions of the model are that: (1) noise trader risk is systematic and (2) it is priced in the market. The results presented in this paper do not provide support for either of these propositions. The risk associated with fluctuations in closed-end fund discounts or premiums is, to a large extent, diversifiable and investors who hold closed-end funds do not earn an additional risk premium for shouldering the so-called “noise trader risk.” Furthermore, our results suggest that noise traders are driven from the market by rational investors who trade against them. We also do not find a significant relation between proxies for individual investor sentiment and closed-end fund discounts.