Informational and Allocative Efficiency in Financial Markets with Costly Information
AbstractCostly information acquisition is introduced into a dynamic trading model of Glosten and Milgrom (1985). The market maker and some traders, called "value traders," value the asset at its fundamental value, which can be either high or low. The remaining traders, called "liquidity traders," have idiosyncratic valuations that are independent of the fundamental. At a cost, each value trader can acquire an informative, but imperfect, signal about the fundamental. In this setting, at equilibrium, each value trader acquires the signal if and only if the uncertainty about the fundamental's value conditional on publicly available information is sufficiently high. Thus, the prices quoted by the market maker are "informationally inefficient," as they do not reveal the value of the fundamental, even in the long-run. Equilibrium amount of information acquisition is either excessive or insufficient relative to the social optimum and results in an inefficient allocation of the asset among the market maker and liquidity traders.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 1403.
Date of creation: Mar 2014
Date of revision:
Contact details of provider:
Postal: Malet Street, London WC1E 7HX, UK
Phone: 44-20- 76316429
Fax: 44-20- 76316416
Web page: http://www.ems.bbk.ac.uk/
Find related papers by JEL classification:
- D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-04-11 (All new papers)
- NEP-CTA-2014-04-11 (Contract Theory & Applications)
- NEP-FMK-2014-04-11 (Financial Markets)
- NEP-GER-2014-04-11 (German Papers)
- NEP-MST-2014-04-11 (Market Microstructure)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- V. V. Chari & Patrick J. Kehoe, 2003.
"Financial crises as herds: overturning the critiques,"
316, Federal Reserve Bank of Minneapolis.
- Chari, V. V. & Kehoe, Patrick J., 2004. "Financial crises as herds: overturning the critiques," Journal of Economic Theory, Elsevier, vol. 119(1), pages 128-150, November.
- V. V. Chari & Patrick J. Kehoe, 2003. "Financial Crises as Herds: Overturning the Critiques," NBER Working Papers 9658, National Bureau of Economic Research, Inc.
- Dasgupta, Amil & Prat, Andrea, 2008. "Information aggregation in financial markets with career concerns," Journal of Economic Theory, Elsevier, vol. 143(1), pages 83-113, November.
- Marco Cipriani & Antonio Guarino, .
"Herd Behavior and Contagion in Financial Markets,"
2010-01, The George Washington University, Institute for International Economic Policy.
- Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
- Lawrence R. Glosten & Paul R. Milgrom, 1983.
"Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders,"
570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
- Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
- Andreas Park & Hamid Sabourian, 2011.
"Herding and Contrarian Behavior in Financial Markets,"
Econometric Society, vol. 79(4), pages 973-1026, 07.
- Park, A. & Sabourian, H., 2009. "Herding and Contrarian Behaviour in Financial Markets," Cambridge Working Papers in Economics 0939, Faculty of Economics, University of Cambridge.
- Banerjee, Abhijit V, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, MIT Press, vol. 107(3), pages 797-817, August.
- Grossman, Sanford J & Stiglitz, Joseph E, 1980.
"On the Impossibility of Informationally Efficient Markets,"
American Economic Review,
American Economic Association, vol. 70(3), pages 393-408, June.
- Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
- Maria Grazia Romano, 2007.
"Learning, Cascades, and Transaction Costs,"
Review of Finance,
European Finance Association, vol. 11(3), pages 527-560.
- Kübler, Dorothea & Weizsäcker, Georg, 2000.
"Limited depth of reasoning and failure of cascade formation in the laboratory,"
SFB 373 Discussion Papers
2001,3, Humboldt University of Berlin, Interdisciplinary Research Project 373: Quantification and Simulation of Economic Processes.
- Dorothea Kübler & Georg Weizs�cker, 2004. "Limited Depth of Reasoning and Failure of Cascade Formation in the Laboratory," Review of Economic Studies, Oxford University Press, vol. 71(2), pages 425-441.
- Prat, Andrea & Dasgupta, Amil, 2006. "Financial equilibrium with career concerns," Theoretical Economics, Econometric Society, vol. 1(1), pages 67-93, March.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().
If references are entirely missing, you can add them using this form.