The Social Value of Information Uncertainty
52 Pages Posted: 28 Feb 2019 Last revised: 29 Jul 2022
Date Written: February 12, 2019
Information acquisition can favor social welfare despite that informed trading distorts risk-sharing and destroys trading opportunities. We analyze a Grossman-Stiglitz economy with homogeneous valuation and heterogeneous endowment shocks, where acquiring information is costly and uncertain. Investors optimally choose the probability to be informed by paying a monetary cost. The
probabilistic information choice generates an anticipatory welfare benefit that can lead to an overall welfare improvement when it offsets the cost of informed trading. Welfare improvement due to information acquisition can be substantial when risk-sharing incentives are weak, endowment shocks are small, and information precision is moderate, especially for speculators who provide liquidity. With heterogeneous endowment shocks, there can be a continuum of Pareto optimal information acquisition equilibria, while the no-information equilibrium is the unique Pareto-optimal equilibrium only when investors have strong risk-sharing incentives.
Keywords: social welfare, information acquisition uncertainty, probabilistic choices, rational expectations equilibrium
JEL Classification: D82, G12, G14
Suggested Citation: Suggested Citation