Learning Whether Other Traders Are Informed
Northwestern University - Kellogg School of Management - Department of Finance
Brett S. Green
University of California, Berkeley - Haas School of Business
July 10, 2013
We develop a dynamic model in which some investors are uncertain about whether others are informed, and gradually learn about them by observing prices and dividends. The model gives rise to a rich set of implications for return dynamics. First, expected returns and return volatility are both stochastic and persistent, even though fundamentals and signals are i.i.d. Second, the price reaction to information about dividends is asymmetric: the price reacts more strongly to bad news than it does to good news. In fact, the price can even decrease with good news about fundamentals. Third, the model generates volatility clustering in which large return realizations, which are associated with dividend surprises, are followed by higher future volatility and higher expected returns. Finally, the relation between information quality and returns varies endogenously over time and depends on the degree of disagreement across investors.
Number of Pages in PDF File: 43
Keywords: Asset Prices, Trade, Learning, Asymmetric Information, Rational Expectations
JEL Classification: G12, G14working papers series
Date posted: September 2, 2012 ; Last revised: July 13, 2013
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