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How heterogeneous information induces market inefficiencies

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  • Rieder, Markus J.

Abstract

We attribute varying returns in a trading market to heterogeneously informed investors. A general framework to model asymmetric information is proposed and shown to result in closed-form solutions to problems that have not been solved analytically, including risk and return profiles across various information states. Under a non-cumulative, noise-free information gathering regime, we derive an analytic expression for expected returns that aligns with economic intuition. When noise is added, we observe an increase in market efficiency, contrary to the belief that such an improvement is achievable solely through valuable information. Assuming cumulative information gathering, we derive analytic return profiles that were previously obtained only through simulations or observed in market experiments.The proposed model for returns in closed trading markets may serve as a general framework for analyzing any kind of information distribution. It also challenges market efficiency since, without any additional assumptions on risk or utility, performance differences arise solely from heterogeneously informed investors.

Suggested Citation

  • Rieder, Markus J., 2025. "How heterogeneous information induces market inefficiencies," Journal of Behavioral and Experimental Finance, Elsevier, vol. 46(C).
    • Handle: RePEc:eee:beexfi:v:46:y:2025:i:c:s2214635025000334
    DOI: 10.1016/j.jbef.2025.101052
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    Keywords

    Information economics; market inefficiencies; excess returns; closed-form solutions;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • D70 - Microeconomics - - Analysis of Collective Decision-Making - - - General

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