Follow the Leader: Informative Voluntary Disclosure and Exploitation

Abstract

This paper develops a model of strategic disclosure by large traders with private information. Trading on private information comes with the risk that adverse price moves will force liquidation before the information is realized. Voluntary disclosure of holdings lets a well-reputed trader profit from the immediate price reaction, before any potential forced liquidation. However, he can also exploit his reputation by disclosing uninformative liquidity trades to earn additional profits. We analyze this situation in a model of a repeated interaction between the public and an informed trader with a reputation for receiving private informative signals. We show that the trader will optimally restrict his frequency of exploitation, but will engage in more exploitation as his reputation improves. Consequently, statements by top experienced traders may be less informative than those made by younger traders with a strong incentive to build a reputation for the future. We test these and other empirical implications of the model using data on voluntary disclosures by mutual fund managers.

Keywords: Large Trader, Trade Disclosure, Forced Liquidation Risk, Reputation, Repeated Games.

JEL Classification: G14