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Information Diversity and Market Efficiency Spirals

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  • Liyan Yang

    (Joseph L. Rotman School of Management,)

  • Itay Goldstein

    (University of Pennsylvania)

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    Abstract

    We analyze a model where the value of a traded security is affected by two different fundamentals, e.g., the quality of the firm's technology and the demand for its products, and where there are two groups of informed traders, each one informed about a different fundamental. We analyze the interaction between the informativeness of the price about the two fundamentals and characterize when it leads to attenuation and when it leads to amplification of shocks to market efficiency. Amplification occurs because the informativeness about one fundamental reduces the uncertainty in trading on information about the other fundamental and encourages traders to trade more aggressively on such information. This effect is dominant when the informativeness of the price is relatively balanced between the two fundamentals, which implies that economies with more diverse information -- i.e., where the information is more evenly distributed between the two groups -- will exhibit positive externalities and have higher levels of overall market efficiency. Finally, we endogenize the incentives for information production and show that the above effect leads to strategic complementarities in information production.

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    File URL: http://www.economicdynamics.org/meetpapers/2012/paper_349.pdf
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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 349.

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    Date of creation: 2012
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    Handle: RePEc:red:sed012:349

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    1. Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-57, May.
    2. Moscarini, Giuseppe, 2004. "Limited information capacity as a source of inertia," Journal of Economic Dynamics and Control, Elsevier, vol. 28(10), pages 2003-2035, September.
    3. Antonio Mele & Francesco Sangiorgi, 2009. "Ambiguity, Information Acquisition and Price Swings in Asset Markets," FMG Discussion Papers dp633, Financial Markets Group.
    4. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, vol. 22(3), pages 477-498, June.
    5. Harrison Hong & Jeremy C. Stein, 2003. "Simple Forecasts and Paradigm Shifts," NBER Working Papers 10013, National Bureau of Economic Research, Inc.
    6. Kathy Yuan, 2005. "The Liquidity Service Of Benchmark Securities," Journal of the European Economic Association, MIT Press, vol. 3(5), pages 1156-1180, 09.
    7. Xavier Gabaix & David Laibson & Guillermo Moloche & Stephen Weinberg, 2006. "Costly Information Acquisition: Experimental Analysis of a Boundedly Rational Model," American Economic Review, American Economic Association, vol. 96(4), pages 1043-1068, September.
    8. Lin Peng & Wei Xiong, 2005. "Investor Attention: Overconfidence and Category Learning," NBER Working Papers 11400, National Bureau of Economic Research, Inc.
    9. Eitan Goldman, 2005. "Organizational Form, Information Collection, and the Value of the Firm," The Journal of Business, University of Chicago Press, vol. 78(3), pages 817-840, May.
    10. Peng, Lin, 2005. "Learning with Information Capacity Constraints," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(02), pages 307-329, June.
    11. Jayant Vivek Ganguli & Liyan Yang, 2009. "Complementarities, Multiplicity, and Supply Information," Journal of the European Economic Association, MIT Press, vol. 7(1), pages 90-115, 03.
    12. Péter Kondor, 2012. "The More We Know about the Fundamental, the Less We Agree on the Price," Review of Economic Studies, Oxford University Press, vol. 79(3), pages 1175-1207.
    13. Diego García & Günter Strobl, 2011. "Relative Wealth Concerns and Complementarities in Information Acquisition," Review of Financial Studies, Society for Financial Studies, vol. 24(1), pages 169-207.
    14. Cespa, Giovanni & Foucault, Thierry, 2011. "Learning from Prices, Liquidity Spillovers, and Market Segmentation," CEPR Discussion Papers 8350, C.E.P.R. Discussion Papers.
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