(In)efficiency in Information Acquisition and Aggregation through Prices

Abstract

We study the interaction between the inefficiency in the acquisition of private information and trading in financial markets. We show that, as the cost of information declines, traders over-invest in information acquisition and trade too much on their private information. We also show that, generically, there exists no policy based on the price of the financial asset and the volume of individual trades that implements efficiency in both information acquisition and trading. Such an impossibility result, however, turns into a possibility result when information acquisition is verifiable, or when taxes can be made contingent on the aggregate volume of trade.

Keywords: information acquisition, aggregation through prices, information externalities, team efficiency.

JEL Classification: D84, G14