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Information, market power and welfare

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  • Lou, Youcheng
  • Rahi, Rohit

Abstract

We study a financial market in which agents with interdependent values bid for a risky asset. Some agents are privately informed of their own value for the asset while others seek to infer it from the equilibrium price. Due to adverse selection, uninformed agents are less willing than the informed to provide liquidity, and engage in greater bid shading when prices are more informative. While increased participation by informed agents leads to perfect competition in the limit, the market remains illiquid to some degree even with free entry of uninformed traders. The incentive to produce information is increasing in market size and is maximal in a perfectly competitive economy. Price informativeness, on the other hand, is independent of market size. Curtailing information production by one group can reduce adverse selection, and improve liquidity and welfare for all agents.

Suggested Citation

  • Lou, Youcheng & Rahi, Rohit, 2021. "Information, market power and welfare," LSE Research Online Documents on Economics 118843, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:118843
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    File URL: http://eprints.lse.ac.uk/118843/
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    References listed on IDEAS

    as
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    Cited by:

    1. Lou, Youcheng & Yang, Yaqing, 2023. "Information linkages in a financial market with imperfect competition," Journal of Economic Dynamics and Control, Elsevier, vol. 150(C).
    2. Ji, Yucheng & Xu, Weijun & Zhao, Qi & Jia, Zecheng, 2023. "ESG disclosure and investor welfare under asymmetric information and imperfect competition," Pacific-Basin Finance Journal, Elsevier, vol. 78(C).
    3. Zhou, Xuan & Kang, Junqing, 2023. "Searching for ESG Information: Heterogeneous Preferences and Information Acquisition," Journal of Economic Dynamics and Control, Elsevier, vol. 153(C).

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    More about this item

    Keywords

    double auction; interdependent values; market power; adverse selection; information acquisition; welfare;
    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

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