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Dynamic market participation and endogenous information aggregation

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  • Edison Yu

Abstract

This paper studies information aggregation in financial markets with recurrent investor exit and entry. I consider a dynamic general equilibrium model of asset trading with private information and collateral constraints. Investors differ in their aversion to Knightian uncertainty: When uncertainty is high, some investors exit the market. Since exiting investors' information is not fully revealed by prices, conditional return volatility and risk premia both increase. I use data on institutional investors' holdings of individual stocks to show that investor exits indeed move negatively with price in-formativeness. The model also implies that exit is more likely when wealth is more concentrated in the hands of less uncertainty-averse investors. The model thus predicts less informative prices toward the end of a long boom, as seen in the data. Moreover, economies with looser collateral constraints should see more volatility due to exit and partial revelation. Higher capital requirements can improve welfare by inducing more information revelation by prices.

Suggested Citation

  • Edison Yu, 2013. "Dynamic market participation and endogenous information aggregation," Working Papers 13-42, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:13-42
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    Cited by:

    1. DiMaggio, Marco & Kermani, Amir & Ramcharan, Rodney & Yu, Edison, 2017. "Household Credit and Local Economic Uncertainty," Working Papers 17-21, Federal Reserve Bank of Philadelphia.

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