Uncertainty, Information Acquisition and Price Swings in Asset Markets
Review of Economic Studies (2015) 82 (4): 1533-1567
85 Pages Posted: 6 May 2009 Last revised: 1 Feb 2018
Date Written: March 15, 2015
This paper analyzes costly information acquisition in asset markets with Knightian uncertainty about the asset fundamentals. In these markets, acquiring information not only reduces the expected variability of the fundamentals for a given distribution (i.e., risk). It also mitigates the uncertainty about the true distribution of the fundamentals. Agents who lack knowledge of this distribution cannot correctly interpret the information other investors impound into the price. We show that, due to uncertainty aversion, the incentives to reduce uncertainty by acquiring information increase as more investors acquire information. When uncertainty is high enough, information acquisition decisions become strategic complements and lead to multiple equilibria. Swift changes in information demand can drive large price swings even after small changes in Knightian uncertainty.
Keywords: Asset markets with Knightian uncertainty, asymmetric information, value of parameter uncertainty, information complementarities, multiple equilibria
JEL Classification: G12, G14, D82
Suggested Citation: Suggested Citation