Public Information and Uninformed Trading: Implications for Market Liquidity and Price Efficiency

66 Pages Posted: 11 Sep 2014 Last revised: 26 Feb 2016

See all articles by Bing Han

Bing Han

University of Toronto, Rotman School of Management

Ya Tang

Peking University - Guanghua School of Management

Liyan Yang

University of Toronto - Rotman School of Management

Date Written: January 2016

Abstract

We develop a rational expectations equilibrium model in which noise trading comes from discretionary liquidity traders. The equilibrium quantity of aggregate noise trading is endogenously determined by the population size of liquidity traders active in the financial market. By improving market liquidity, public information reduces the expected trading loss of liquidity traders and thus attracts more such traders to the market, which negatively affects information aggregation. Analyzing an alternative setting that models noise trading as coming from hedgers yields similar insights. In a setting with endogenous information, public information can harm information aggregation both through crowding out private information and through attracting noise trading.

Keywords: Discretionary liquidity trading, market liquidity, information aggregation, information production, hedging

JEL Classification: D61, G14, G30, M41

Suggested Citation

Han, Bing and Tang, Ya and Yang, Liyan, Public Information and Uninformed Trading: Implications for Market Liquidity and Price Efficiency (January 2016). Journal of Economic Theory, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2493825

Bing Han

University of Toronto, Rotman School of Management ( email )

Toronto, Ontario M5S 3E6
Canada
4169460732 (Phone)

Ya Tang

Peking University - Guanghua School of Management ( email )

No. 38 Xueyuan Road
Haidian District
Beijing, Beijing 100871
China

Liyan Yang (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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