Information Disclosure in Financial Markets

Abstract

Information disclosure is an essential component of regulation in financial markets. In this article, we provide a cohesive analytical framework to review a few key channels through which disclosure in financial markets affects market quality, information production, efficiency of real investment decisions, and traders' welfare. We use our framework to cover four main aspects. First, we demonstrate the conventional wisdom that disclosure improves market quality in an economy with exogenous information. Second, we illustrate that disclosure can crowd out the production of private information, and that its overall market-quality implications are more subtle and depend on the specification of information-acquisition technology. Third, we review how disclosure affects the efficiency of real investment decisions when financial markets are not just a side show, as real decision makers can learn information from them to guide their decisions. Last, we discuss how disclosure in financial markets affects investor welfare through changing trading opportunities and through beauty-contest motives. Overall, our review suggests that information disclosure is an important factor for understanding the functioning of financial markets and that there are several trade-offs that need to be considered in determining its optimal level.

Keywords: disclosure, market quality, crowding-out effect, learning from prices, real efficiency, welfare

JEL Classification: G14, D83