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Information acquisition and financial intermediation

Informational advantages of specialists relative to households lead to disagreement between the two in an intermediated market. Although households can acquire additional signals to reduce the informational asymmetry, the additional information is costly, making it rational for households to limit the accuracy of the signals they observe. I show that this leads the equity capital constraint to bind more frequently, making the asset prices in the economy more volatile unconditionally. When disagreement between households and specialists is high, however, return volatility decreases. I find empirical evidence consistent with these predictions.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 571.

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Length: 55 pages
Date of creation: 2012
Date of revision: 01 Jun 2014
Handle: RePEc:fip:fednsr:571
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  1. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  2. Douglas W. Diamond & Raghuram G. Rajan, 2002. "Liquidity Shortages and Banking Crises," NBER Working Papers 8937, National Bureau of Economic Research, Inc.
  3. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  4. Hong, Harrison & Torous, Walter & Valkanov, Rossen, 2007. "Do industries lead stock markets?," Journal of Financial Economics, Elsevier, vol. 83(2), pages 367-396, February.
  5. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
  6. Christopher A. Sims, 2006. "Rational Inattention: Beyond the Linear-Quadratic Case," American Economic Review, American Economic Association, vol. 96(2), pages 158-163, May.
  7. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," NBER Working Papers 8896, National Bureau of Economic Research, Inc.
  8. Lixin Huang & Hong Liu, 2007. "Rational Inattention and Portfolio Selection," Journal of Finance, American Finance Association, vol. 62(4), pages 1999-2040, 08.
  9. Allen, Franklin & Gale, Douglas, 1994. "Limited Market Participation and Volatility of Asset Prices," American Economic Review, American Economic Association, vol. 84(4), pages 933-55, September.
  10. Marcin Kacperczyk & Stijn Van Nieuwerburgh & Laura Veldkamp, 2009. "Rational Attention Allocation Over the Business Cycle," NBER Working Papers 15450, National Bureau of Economic Research, Inc.
  11. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  12. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August.
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