Heterogeneous awareness in financial markets

The overlook of some economic scenarios may result in unforeseen negative outcomes for investors. In this paper, we consider an order-driven financial market in which a fraction of the traders is only partially aware of the possible payoffs of a risky asset, but is aware of the possibility of facing unknown contingencies. Investors decide whether to acquire a costly signal about the payoff of the risky asset and whether to buy such asset given their awareness level and their perceived relations among signals, order flows, and prices. We show that as unawareness becomes more severe, the value of the signal to the partially aware traders diminishes. In turn, through its impact on the price, the reduced number of partially aware informed investors increases the incentives of the fully aware to acquire the signal. In the aggregate, the latter effect does not outweigh the former, so that the overall proportion of informed investors in the market is (weakly) decreasing in the unawareness level. As for the equilibrium price, a lower amount of informed traders makes it more difficult for market makers to distinguish between good and bad signals, and this brings the conditional expectations of the price closer to the unconditional one and reduces the price variance.