Information, Trade and Derivative Securities

Abstract

In this paper, we address the introduction of new markets in the context of a noisy rational expectations model of the type of Hellwig (1990), by assuming that knowledge about final payoffs emerges gradually over time and then considering the effect of allowing investors to trade more frequently. This welfare gain for an individual investor from more frequent trading is shown to be an increasing function of the absolute value of the difference between the precision of his prior information and the risk tolerance weighted average precision of all investors; it is also (and equivalently) an increasing function of the volume of trade of the investor. We also demonstrate that, for a given number of market sessions, welfare is maximized when information is released in such a way that the variance of price change between successive market sessions is constant over time. This result provides a social justification for disclosure laws that require firms to disclose material new information immediately, rather than saving the disclosure for the periodic financial statement dates.

JEL Classification: G14