Bubbles, Fads and Stock Price Volatility Tests: A Partial Evaluation; Discussion

An analysis indicates that neither rational bubbles nor traditional methods of return determination can explain stock price volatility. A "fads" interpretation of volatility tests is proposed as an alternative. In this method, noise trading by naive investors is significant in determining stock prices. In one interpretation, fads mean that there are still opportunities for profit even after risk adjustments. In another interpretation, some trading is done by both naive investors and by sophisticated investors, but stock prices are not driven to the level they would be in the absence of fads. The naive investors create risk, which the sophisticated investors must take into account. Traditional models might not be able to capture this risk, however. In his discussion, Kleidon says that the exclusion of certain studies and data means that West's conclusions must be viewed with reservation.