Active Investment, Liquidity Externalities, and Markets for Information

Abstract:     
Informed investors are a source of illiquidity, but those pursuing differently informed strategies also generate quasi-noise trading. Quasi-noise trading creates non-monotonic externalities in information choice that shape the composition of active investment and that influence investor herding, liquidity spirals, asset comovement, along with the information content of prices. These externalities also affect information markets. An information vendor with market power expands sales only to monopolize investor attention, which can make prices less informative. By contrast, vendor competition boosts quasi-noise trading, which promotes investor diversity. Finally, selling information can be a means to create liquidity for proprietary trades.

Number of Pages in PDF File: 65

Keywords: Market liquidity, quasi-noise trading, information acquisition, information market

JEL Classification: D82, D83, G14

working papers series