Active Investment, Liquidity Externalities, and Markets for Information

Abstract

This paper studies speculators’ demand and supply for diverse information. The general insights are that liquidity externalities can generate complementarities in information acquisition and information sales are strategic means to manipulate liquidity. Three specific results illustrate these insights. First, there exist liquidity-information spirals in which decreases in information acquisition across trading strategies are mutually reinforcing as attrition in any strategy withdraws liquidity from others. Second, information sales can serve to crowd out alternative strategies and thus alternative information from prices. Third, it can pay to combine proprietary trading with information dissemination since the latter can generate liquidity for the former.

Keywords: Information diversity, quasi-noise trading, liquidity spirals, complementarities in information acquisition, information sales

JEL Classification: D82, D83, G14