Noise-trader risk
Mispricing can get worse before it gets better, and that danger scares off arbitrageurs.
What it means
The risk that the irrational sentiment driving a mispricing will intensify in the short run, moving prices further from value and inflicting losses on arbitrageurs who bet on correction. Because arbitrageurs have finite horizons, borrowed capital, and clients who may withdraw funds after interim losses, this unpredictability makes correcting mispricing genuinely risky rather than a free lunch. It is a central pillar of the limits-to-arbitrage argument and explains why even confident, well-informed traders may decline to trade against a bubble. It matters because it shows mispricing can persist not from a lack of smart money but because smart money is rationally cautious.
Examples
A short-seller right that a stock is overvalued is wiped out when euphoria pushes it higher still before the eventual collapse.
Fund managers who avoided dot-com stocks in the late 1990s lost clients tired of missing the boom; being right about the bubble did not pay until it finally burst.
A trader spots an obviously overpriced housing-linked bond but leaves it alone: her fund is judged quarterly, and the mispricing could easily widen for another year first.
First described in De Long, Shleifer, Summers & Waldmann (1990); Shleifer & Vishny (1997).