Mmmmmmm

Noise Fischer Black The Journal of Finance, Vol. 41, No. 3, Papers and Proceedings of the Forty-Fourth Annual Meeting of the America Finance Association, New York, New York, December 28-30, 1985. (Jul., 1986), pp. 529-543.
Stable URL: http://links.jstor.org/sici?sici=0022-1082%28198607%2941%3A3%3C529%3AN%3E2.0.CO%3B2-9 The Journal of Finance is currently published by American FinanceAssociation.

Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/about/terms.html. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for yourpersonal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/journals/afina.html. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission.

The JSTOR Archive is a trusted digital repository providingfor long-term preservation and access to leading academic journals and scholarly literature from around the world. The Archive is supported by libraries, scholarly societies, publishers, and foundations. It is an initiative of JSTOR, a not-for-profit organization with a mission to help the scholarly community take advantage of advances in technology. For more information regarding JSTOR, pleasecontact support@jstor.org.

http://www.jstor.org Sun Aug 5 21:09:02 2007

Fischer Black President of the American Finance Association
1985

T H E JOURNAL OF FINANCE

VOL. XLI, NO. 3

JULY 1986

FISCHER BLACK*
ABSTRACT
The effects of noise on the world, and on our views of the world, are profound. Noise in the sense of a large number of small events is often a causal factor much morepowerful than a small number of large events can be. Noise makes trading in financial markets possible, and thus allows us to observe prices for financial assets. Noise causes markets to be somewhat inefficient, but often prevents us from taking advantage of inefficiencies. Noise in the form of uncertainty about future tastes and technology by sector causes business cycles, and makes them highlyresistant to improvement through government intervention. Noise in the form of expectations that need not follow rational rules causes inflation to be what it is, at least in the absence of a gold standard or fixed exchange rates. Noise in the form of uncertainty about what relative prices would be with other exchange rates makes us think incorrectly that changes in exchange rates or inflationrates cause changes in trade or investment flows or economic activity. Most generally, noise makes it very difficult to test either practical or academic theories about the way that financial or economic markets work. We are forced to act largely in the dark.

I USE THE WORD "noise" in several senses in this paper. In my basic model of financial markets, noise is contrasted with information. Peoplesometimes trade on information in the usual way. They are correct in expecting to make profits from these trades. On the other hand, people sometimes trade on noise as if it were information. If they expect to make profits from noise trading, they are incorrect. However, noise trading is essential to the existence of liquid markets. In my model of the way we observe the world, noise is what makesour observations imperfect. It keeps us from knowing the expected return on a stock or portfolio. It keeps us from knowing whether monetary policy affects inflation or unemployment. It keeps us from knowing what, if anything, we can do to make things better. In my model of inflation, noise is the arbitrary element in expectations that leads to an arbitrary rate of inflation consistent with...