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Profitable Informed Trading in a Simple General Equilibrium Model of Asset Pricing

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  • James Dow
  • Gary Gorton

Abstract

This paper presents a simple general equilibrium model of asset pricing in which profitable informed trading can occur without any "noise" added to the model. It shows that models of profitable informed trading must restrict the portfolio choices of uninformed traders: in particular, they cannot buy the market portfolio. In this model, profitable informed trading lowers the welfare of all agents when compared across steady states.

Suggested Citation

  • James Dow & Gary Gorton, 1993. "Profitable Informed Trading in a Simple General Equilibrium Model of Asset Pricing," NBER Working Papers 4315, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:4315
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    Cited by:

    1. Habib, Michel A. & Johnsen, D. Bruce & Naik, Narayan Y., 1997. "Spinoffs and Information," Journal of Financial Intermediation, Elsevier, vol. 6(2), pages 153-176, April.
    2. Dow, James & Gorton, Gary, 1997. "Noise Trading, Delegated Portfolio Management, and Economic Welfare," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 1024-1050, October.
    3. Cedric Tille & Eric van Wincoop, 2009. "Disconnect and Information Content of International Capital Flows: Evidence and Theory," Working Papers 102009, Hong Kong Institute for Monetary Research.
    4. Philippe Bacchetta & Eric Van Wincoop, 2006. "Can Information Heterogeneity Explain the Exchange Rate Determination Puzzle?," American Economic Review, American Economic Association, vol. 96(3), pages 552-576, June.
    5. Bacchetta, Philippe & van Wincoop, Eric, 2021. "Puzzling exchange rate dynamics and delayed portfolio adjustment," Journal of International Economics, Elsevier, vol. 131(C).
    6. Bond, Philip & Eraslan, Hülya, 2010. "Information-based trade," Journal of Economic Theory, Elsevier, vol. 145(5), pages 1675-1703, September.
    7. Philippe Bacchetta & Eric van Wincoop, 2005. "Can Information Heterogeneity Explain the Exchange Rate Determination?," FAME Research Paper Series rp155, International Center for Financial Asset Management and Engineering.
    8. Palan, Stefan & Stöckl, Thomas, 2017. "When chasing the offender hurts the victim: The case of insider legislation," Journal of Financial Markets, Elsevier, vol. 35(C), pages 104-129.
    9. Dow, James & Gorton, Gary, 1997. "Stock Market Efficiency and Economic Efficiency: Is There a Connection?," Journal of Finance, American Finance Association, vol. 52(3), pages 1087-1129, July.
    10. David Aboody & John Hughes & Jing Liu, 2005. "Earnings Quality, Insider Trading, and Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 43(5), pages 651-673, December.
    11. Philip Bond & Hulya Eraslan, 2007. "Information-based trade," Levine's Bibliography 122247000000001689, UCLA Department of Economics.
    12. van Wincoop, Eric & Tille, Cédric, 2008. "International Capital Flows under Dispersed Information: Theory and Evidence," CEPR Discussion Papers 6989, C.E.P.R. Discussion Papers.
    13. Mouselli, Sulaiman & Jaafar, Aziz & Goddard, John, 2013. "Accruals quality, stock returns and asset pricing: Evidence from the UK," International Review of Financial Analysis, Elsevier, vol. 30(C), pages 203-213.
    14. James Dow & Gary Gorton, 2006. "Noise Traders," NBER Working Papers 12256, National Bureau of Economic Research, Inc.
    15. Tille, Cédric & van Wincoop, Eric, 2014. "International capital flows under dispersed private information," Journal of International Economics, Elsevier, vol. 93(1), pages 31-49.

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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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