Information Diversity and Complementarities in Trading and Information Acquisition

Abstract

We analyze a model where different traders are informed of different fundamentals that affect the security value. We identify a source for strategic complementarities in trading and information acquisition: The aggressive trading on information about one fundamental reduces the uncertainty in trading on information about the other fundamental, encouraging more trading and information acquisition on that fundamental. This tends to amplify the effect of exogenous changes in the underlying information environment. Due to complementarities, greater diversity of information in the economy improves price informativeness. We discuss the relation between our model and recent financial phenomena and derive testable empirical implications.

Keywords: information diversity, uncertainty reduction effect, price informativeness, complementarity

JEL Classification: G14, G12, G11, D82