The DSSW model enriches our understanding of asset price fluctuations by demonstrating how noise traders contribute to market volatility. Their irrational trading based on misjudged information can lead to significant deviations from fundamental asset values . Although rational arbitrageurs attempt to correct these mispricings, their ability to do so is limited by the risks introduced by noise traders and the short-term nature of their investment horizons . This dynamic interplay is crucial in explaining the often substantial and unpredictable fluctuations observed in financial markets .

The DSSW model suggests that noise trading undermines the predictive efficiency of financial markets by causing asset prices to deviate from their fundamental values due to misjudged information . Noise traders, acting on false signals, create volatility that rational traders cannot fully correct due to arbitrage constraints . This persistent mispricing implies that asset prices reflect not only fundamental information but also non-fundamental noise, thereby challenging the market's ability to predictably reflect true asset values .

The DSSW model distinguishes between noise traders and rational traders based on their information processing and investment strategies. Noise traders mistakenly believe they possess special insights about future asset prices, often based on false signals or technical analysis, leading to irrational investment decisions . Rational traders, in contrast, base their strategies on exploiting these irrational behaviors through a contrarian trading approach, aiming to profit from price discrepancies created by noise traders . The interaction between these two groups affects financial markets by introducing noise that causes asset prices to deviate from their fundamental values and creates arbitrage opportunities for rational traders, though these opportunities come with risks due to the unpredictability of noise traders' actions .

The DSSW model posits that noise traders create their 'living space' through the additional risks they introduce to the market, which deter rational traders from fully exploiting arbitrage opportunities . Since rational traders face the risk of price movements contrary to expected corrections within their short-term investment horizons, they cannot always capitalize on perceived arbitrage opportunities without potentially incurring losses . This self-sustaining mechanism allows noise traders to persist in the markets, as the risks they introduce create barriers to market corrections, enabling their continual influence on asset prices .

According to the DSSW model, noise traders have problems with information quality, leading to a misunderstanding of the fundamentals of risky assets . This causes them to engage in excessive or insufficient demand compared to rational traders, thereby affecting the prices of these assets . Noise traders’ actions introduce price distortions, which rational traders attempt to exploit for profit through arbitrage, although this process is limited by the risks and investment horizon constraints that noise traders inherently introduce .

Noise traders can sometimes earn higher expected returns than rational investors due to the risks they induce in the market, which discourage full arbitrage by rational investors and lead to asset prices deviating significantly from fundamentals . Rational traders, while avoiding excessive risk, might refrain from exploiting these price deviations fully, allowing noise traders to benefit from the volatility and mispricings they help create . Thus, ironically, noise-induced trading can lead to returns that, in certain market conditions, surpass those derived from more rational, risk-averse strategies .

The DSSW model departs from classical financial theories, which assume all investors are rational and can predict asset prices based on accurate fundamental information . Classical models suggest that financial markets operate seamlessly with prices reflecting all available information. However, the DSSW model introduces the concept of noise traders, whose irrational actions lead to significant price fluctuations that classical theories can't adequately explain . This model addresses the gaps in understanding the volatility and unpredictability inherent in real-world markets, providing a structured approach to analyze the effects of non-fundamental information on asset pricing .

In the DSSW model, rational arbitrage strategies face limitations due to noise trader risks and the short-term investment horizons of rational traders. These factors hinder their ability to exploit price discrepancies fully before those opportunities vanish and can sometimes lead to losses if the asset prices move unfavorably before the positions are liquidated . Consequently, the rational traders' role in correcting mispricings is mitigated, leading to less efficient markets as prices deviate more significantly and frequently from their fundamental values due to these constraints .

Black's interpretation of noise trading expanded beyond Kyle's earlier concept, which associated noise trading primarily with liquidity trading, characterized by actual trading demands . Black instead articulated noise trading as a pivotal aspect of financial markets, recognizing it as both a foundational element and a source of market problems, by highlighting how traders act on misjudged information rather than true market signals . This distinction spurred a broader recognition and research interest into how noise, as defined by Black, influences market dynamics and operations, contrasting with Kyle's more constrained liquidity-based understanding .

Bhushan, Brown, and Mello (1997) challenged the assumption in the DSSW model that the investment period arbitrage limit is critical for defining the strategies of rational traders . They argued that this assumption is not necessarily required and that a more generalized framework could encompass the DSSW model as a special case . This critique implies that the DSSW model might be overly restrictive and its assumptions about arbitrage could limit its applicability in diverse market conditions, leading to a revised understanding of how noise trading influences market dynamics beyond the original model's scope .