Information Trade-Offs in Dynamic Financial Markets

Abstract:     
I develop a model of information acquisition in dynamic financial markets. In equilibrium, prices reflect investors’ expectations about the cash flows and the supply of a risky asset. Contrary to static models, supply has a significant informational role in markets because it predicts capital gains. Investors decide whether to obtain superior information about dividends at a cost, which also enables them to learn information about supply. Investors who decide to be uninformed learn about dividends and supply from prices. I show that as more informed investors enter the economy, prices become more informative about dividends but less informative about supply. This trade-off creates complementarities in information acquisition. As a result, the information market has multiple equilibria, each with different implications for the financial market.

Number of Pages in PDF File: 49

Keywords: information acquisition, dynamic financial markets, information trade-offs, information complementarities

JEL Classification: C68, D58, D82, D83, D84, G14

working papers series