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Information Markets and the Comovement of Asset Prices

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Author Info
Laura Veldkamp

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Abstract

Asset prices display high covariance relative to the covariance of their payoffs. (Pindyck and Rotemberg, 1993; Barberis, Shleifer and Wurgler, 2002) Many take this ‘excess covariance’ to be evidence of investor irrationality. This model reconciles the high covariance with a rational expectations framework by introducing endogenous information acquisition. Investors can purchase information about asset payoffs from a competitive, profit-maximizing seller. A rational investor holding a portfolio of assets will not pay for information about every asset. Instead, he will buy information about a subset of the assets and use this information to make inferences about the value of all his assets. Because information production has high fixed costs, competitive producers charge more for low-demand information than for high-demand information. A price that declines in quantity makes investors want to coordinate their purchases of information to reduce its cost. If investors price many assets using a small number of common signals, then shocks to one signal will be passed on as common shocks to many asset prices. These shocks to asset prices, through common signals, generate 'excess covariance.' The cross-sectional and time-series properties of asset price covariance are consistent with this explanation.

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Publisher Info
Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 539.

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Date of creation: 2004
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Handle: RePEc:red:sed004:539

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Related research
Keywords: comovement; herding; information market;

Other versions of this item:

Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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References listed on IDEAS
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.:
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  2. Morris, S & Song Shin, H, 1996. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," Economics Papers 126, Economics Group, Nuffield College, University of Oxford.
    Other versions:
  3. Geore-Marios Angeletos & Alessandro Pavan, 2004. "Transparency of Information and Coordination in Economies with Investment Complementarities," Levine's Bibliography 122247000000000289, UCLA Department of Economics. [Downloadable!]
    Other versions:
  4. King, Mervyn A & Wadhwani, Sushil, 1990. "Transmission of Volatility between Stock Markets," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 3(1), pages 5-33. [Downloadable!] (restricted)
    Other versions:
  5. John Y. Campbell, 2001. "Have Individual Stocks Become More Volatile? An Empirical Exploration of Idiosyncratic Risk," Journal of Finance, American Finance Association, vol. 56(1), pages 1-43, 02. [Downloadable!] (restricted)
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  6. Randall Morck & Bernard Yeung & Wayne Wu, 1999. "The Information Content of Stock Markets: Why do Emerging Markets have Synchronous Stock Price Movements?," William Davidson Institute Working Papers Series 44, William Davidson Institute at the University of Michigan Stephen M. Ross Business School. [Downloadable!]
    Other versions:
  7. Laura E. Kodres & Matthew Pritsker, 2002. "A Rational Expectations Model of Financial Contagion," Journal of Finance, American Finance Association, vol. 57(2), pages 769-799, 04. [Downloadable!] (restricted)
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  10. Laura Veldkamp, 2004. "Media Frenzies in Markets for Financial Information," Econometric Society 2004 North American Winter Meetings 4, Econometric Society. [Downloadable!]
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  11. Harrison Hong & Jeremy C. Stein, 2003. "Simple Forecasts and Paradigm Shifts," Harvard Institute of Economic Research Working Papers 2007, Harvard - Institute of Economic Research. [Downloadable!]
  12. Robert J. Shiller, 1989. "Comovements in Stock Prices and Comovements in Dividends," NBER Working Papers 2846, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. Nicholas Barberis & Andrei Shleifer & Jeffrey Wurgler, 2002. "Comovement," NBER Working Papers 8895, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Rui Albuquerque & Gregory H. Bauer & Martin Schneider, 2005. "International equity flows and returns: a quantitative equilibrium approach," International Finance 0508006, EconWPA. [Downloadable!]
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  15. Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-57, May. [Downloadable!] (restricted)
  16. Albert S. Kyle, 2001. "Contagion as a Wealth Effect," Journal of Finance, American Finance Association, vol. 56(4), pages 1401-1440, 08. [Downloadable!] (restricted)
  17. Art Durnev & Randall Morck & Bernard Yeung, 2004. "Value-Enhancing Capital Budgeting and Firm-specific Stock Return Variation," Journal of Finance, American Finance Association, vol. 59(1), pages 65-105, 02. [Downloadable!] (restricted)
  18. Pindyck, Robert S & Rotemberg, Julio J, 1993. "The Comovement of Stock Prices," The Quarterly Journal of Economics, MIT Press, vol. 108(4), pages 1073-1104, November. [Downloadable!] (restricted)
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Cited by:
(explanations, 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.)

  1. Yuriy Gorodnichenko, 2008. "Endogenous information, menu costs and inflation persistence," NBER Working Papers 14184, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Felices, Guillermo & Grisse, Christian & Yang, Jing, 2009. "International financial transmission: emerging and mature markets," Bank of England working papers 373, Bank of England. [Downloadable!]
  3. Chollete, Loran & Pena, Victor de la & Lu, Ching-Chih, 2009. "International Diversification: A Copula Approach," UiS Working Papers in Economics and Finance 2009/27, University of Stavanger. [Downloadable!]
  4. Gerard Hoberg & Gordon M. Phillips, 2008. "Real and Financial Industry Booms and Busts," NBER Working Papers 14290, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Guido Lorenzoni, 2006. "A Theory of Demand Shocks," NBER Working Papers 12477, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Chollete, Loran & de la Pena , Victor & Lu, Ching-Chih, 2009. "International Diversification: An Extreme Value Approach," UiS Working Papers in Economics and Finance 2009/26, University of Stavanger. [Downloadable!]
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