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The Role of Information in the Discrepancy Between Average Prices and Expectations

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  • Barbosa, António

Abstract

In this paper I show how the existence of short-term trading causes a divergence between the average price and the average expectation of the fundamental value by embedding higher-order expectations –expectations of expectations of expectations...– into prices. Short-term trading arises when investors receive private information and (i) either net supply mean reverts or (ii) the release of additional information related to existing information is combined with residual uncertainty. Mean-reversion of net supply, brings the average expectation closer to the fundamental value than the average price after the release of private information. By the contrary, residual uncertainty and an incoming release of information brings the average price closer to the fundamental value than the average expectation before the new information is released. When both (i) and (ii) are present, the average expectation tends to be closer to the fundamental value than the average price in the periods immediately after information releases, but the opposite happens in the periods immediately before information releases.

Suggested Citation

  • Barbosa, António, 2019. "The Role of Information in the Discrepancy Between Average Prices and Expectations," MPRA Paper 97416, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:97416
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    References listed on IDEAS

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    1. Cespa, Giovanni, 2002. "Short-term investment and equilibrium multiplicity," European Economic Review, Elsevier, vol. 46(9), pages 1645-1670, October.
    2. He, Hua & Wang, Jiang, 1995. "Differential Information and Dynamic Behavior of Stock Trading Volume," The Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 919-972.
    3. Giovanni Cespa & Xavier Vives, 2012. "Dynamic Trading and Asset Prices: Keynes vs. Hayek," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 79(2), pages 539-580.
    4. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," The Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
    5. Franklin Allen & Stephen Morris & Hyun Song Shin, 2006. "Beauty Contests and Iterated Expectations in Asset Markets," The Review of Financial Studies, Society for Financial Studies, vol. 19(3), pages 719-752.
    Full references (including those not matched with items on IDEAS)

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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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