57 Pages Posted: 17 Mar 2017 Last revised: 26 Jul 2018
Date Written: June 20, 2018
We present a financial market with investors who have nested private information. Small perturbations of price informativeness, coming from distortions of dividend expectations, can trigger an oscillating shock throughout the economy that destabilizes the feedback loop between prices and expectations. Moreover, decreasing the volatility of liquidity trading makes the equilibrium less stable. We investigate what the distribution of informed investors implies for equilibrium stability and for the risk premium of the asset. We find that different investor distributions have different implications, depending on whether adverse-selection or risk-sharing effects dominate in the economy.
Keywords: Rational expectations equilibria, information hierarchy, market stability, risk premium.
JEL Classification: D82, D83, D84, G14
Suggested Citation: Suggested Citation