Journal
MANAGEMENT SCIENCE
Volume -, Issue -, Pages -Publisher
INFORMS
DOI: 10.1287/mnsc.2021.01213
Keywords
finance: asset pricing; asymmetric information; financial crises; information dynamics; general equilibrium
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We propose a model that explains the role of investors in information choices and asset prices. The availability of fundamental information varies over time based on investor demand. The research sector generates more information when investors are willing to pay for research. This feedback mechanism results in two equilibrium regimes, one characterized by high prices and low volatility, and the other by the opposite. The low price, high-volatility regime is associated with greater information asymmetry between informed and uninformed investors. Information dynamics move the market between regimes, causing large price drops even without changes in fundamentals. Calibration of the model suggests the important role of information dynamics in financial crises.
We develop a model of investor information choices and asset prices in which the availability of information about fundamentals is time-varying and responds to investor demand for information. A competitive research sector produces more information when more investors are willing to pay for that research. This feedback, from investor willingness to pay for information to more information production, generates two regimes in equilibrium, one having high prices and low volatility, the other the opposite. The low price, high-volatility regime is associated with greater information asymmetry between informed and uninformed investors. Information dynamics move the market between regimes, creating large price drops even with no change in fundamentals. In our calibration, the model suggests an important role for information dynamics in financial crises.
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