Noise Bubbles

We introduce noisy information into a standard present value stock price model. Agents
receive a noisy signal about the structural shock driving future dividend variations. The
resulting equilibrium stock price includes a transitory component —the “noise bubble”—
which can be responsible for boom and bust episodes unrelated to economic fundamentals. We propose a non-standard VAR procedure to estimate the structural shock and
the “noise” shock, their impulse response functions and the bubble component of stock
prices. We apply such procedure to US data and find that noise explains a large fraction
of stock price volatility. In particular the dot-com bubble is entirely explained by noise.
On the contrary the stock price boom peaking in 2007 is not a bubble, whereas the
following stock market crisis is largely due to negative noise shocks.