Financial Disclosure and Market Transparency with Costly Information Processing
40 Pages Posted: 1 Feb 2013
Date Written: November 2012
We study a model where some investors (hedgers) are bad at information processing, while others (speculators) have superior information-processing ability and trade purely to exploit it. The disclosure of financial information induces a trade externality: if speculators refrain from trading, hedgers do the same, depressing the asset price. Market transparency reinforces this mechanism, by making speculators trades more visible to hedgers. As a consequence, asset sellers will oppose both the disclosure of fundamentals and trading transparency. This is socially inefficient if a large fraction of market participants are speculators and hedgers have low processing costs. But in these circumstances, forbidding hedgers access to the market may dominate mandatory disclosure.
Keywords: financial disclosure, information processing, liquidity, market transparency, rational inattention
JEL Classification: D83, D84, G18, G38, K22, M48
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