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Equilibrium Asset Pricing and Portfolio Choice Under Asymmetric Information

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  • Bruno Biais
  • Peter Bossaerts
  • Chester Spatt

Abstract

We analyze theoretically and empirically the implications of information asymmetry for equilibrium asset pricing and portfolio choice. In our partially revealing dynamic rational expectations equilibrium, portfolio separation fails, and indexing is not optimal. We show how uninformed investors should structure their portfolios, using the information contained in prices to cope with winner's curse problems. We implement empirically this price- contingent portfolio strategy. Consistent with our theory, the strategy outperforms economically and statistically the index. While momentum can arise in the model, in the data, the momentum strategy does not outperform the price-contingent strategy, as predicted by the theory. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 23 (2010)
Issue (Month): 4 (April)
Pages: 1503-1543

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Handle: RePEc:oup:rfinst:v:23:y:2010:i:4:p:1503-1543

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Cited by:
  1. Albuquerque, Rui & Miao, Jianjun, 2014. "Advance information and asset prices," Journal of Economic Theory, Elsevier, vol. 149(C), pages 236-275.
  2. Jayant Ganguli & Scott Condie, 2012. "The pricing effects of ambiguous private information," Economics Discussion Papers, University of Essex, Department of Economics 720, University of Essex, Department of Economics.
  3. Laurent E. Calvet & Veronika Czellar, 2011. "State-Observation Sampling and the Econometrics of Learning Models," Papers 1105.4519, arXiv.org.
  4. Elias Albagli & Christian Hellwig & Aleh Tsyvinski, 2014. "Dynamic Dispersed Information and the Credit Spread Puzzle," NBER Working Papers 19788, National Bureau of Economic Research, Inc.
  5. ap Gwilym, Rhys & Ebrahim, M. Shahid, 2013. "Can position limits restrain ‘rogue’ trading?," Journal of Banking & Finance, Elsevier, vol. 37(3), pages 824-836.
  6. Buckley, Winston & Long, Hongwei & Perera, Sandun, 2014. "A jump model for fads in asset prices under asymmetric information," European Journal of Operational Research, Elsevier, Elsevier, vol. 236(1), pages 200-208.
  7. Murizah Osman Salleh & Aziz Jaafar & M. Shahid Ebrahim, 2011. "The Inhibition of Usury (Riba An-Nasi'ah) and the Economic Underdevelopment of the Muslim World," Working Papers 11002, Bangor Business School, Prifysgol Bangor University (Cymru / Wales).
  8. Gao, Feng & Song, Fengming & Wang, Jun, 2013. "Rational expectations equilibrium with uncertain proportion of informed traders," Journal of Financial Markets, Elsevier, Elsevier, vol. 16(3), pages 387-413.
  9. Kondor, Péter, 2011. "The more we know on the fundamental, the less we agree on the price," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8455, C.E.P.R. Discussion Papers.
  10. Makarov, Igor & Rytchkov, Oleg, 2012. "Forecasting the forecasts of others: Implications for asset pricing," Journal of Economic Theory, Elsevier, vol. 147(3), pages 941-966.
  11. Burlacu, Radu & Fontaine, Patrice & Jimenez-Garcès, Sonia & Seasholes, Mark S., 2012. "Risk and the cross section of stock returns," Journal of Financial Economics, Elsevier, Elsevier, vol. 105(3), pages 511-522.

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