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Optimal research in financial markets with heterogeneous private information a rational expectations model

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Author Info
Katrin Tinn () (London School of Economics, Financial Markets Group, Houghton Street, London, WC2A 2AE, United Kingdom)

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Abstract

This paper investigates prices and endogenous research decision for financial assets. In rational expectations models with public information, higher order beliefs make investors to overweight the public information relative to underlying fundamentals. The extent of this mispricing is higher if the variance of private signals is relatively high. The model presented in this paper extends this setting by incorporating the research cost decision and endogenising the variance of the private signals that short-lived investors obtain in each period. It turns out that investors will be less willing to research in periods when there is an alternative asset with high return available. Furthermore, the optimal research decision will depend on the time left to the maturity of the asset. This explains, in a rational setting, why long lived assets like stocks may be priced based on the public information rather than research on fundamentals.

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Publisher Info
Paper provided by European Central Bank in its series Working Paper Series with number 493.

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Length: 32 pages
Date of creation: Jun 2005
Date of revision:
Handle: RePEc:ecb:ecbwps:20050493

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Related research
Keywords: Financial markets imperfections; heterogeneous information; research costs.;

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

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References listed on IDEAS
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