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Public information and uninformed trading: Implications for market liquidity and price efficiency

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  • Han, Bing
  • Tang, Ya
  • Yang, Liyan

Abstract

We develop a rational expectations equilibrium model in which noise trading comes from discretionary liquidity traders. The equilibrium quantity of aggregate noise trading is endogenously determined by the population size of liquidity traders active in the financial market. By improving market liquidity, public information reduces the expected trading loss of liquidity traders and thus attracts more such traders to the market, which negatively affects information aggregation. Analyzing an alternative setting that models noise trading as coming from hedgers yields similar insights. In a setting with endogenous information, public information can harm information aggregation both through crowding out private information and through attracting noise trading.

Suggested Citation

  • Han, Bing & Tang, Ya & Yang, Liyan, 2016. "Public information and uninformed trading: Implications for market liquidity and price efficiency," Journal of Economic Theory, Elsevier, vol. 163(C), pages 604-643.
    • Handle: RePEc:eee:jetheo:v:163:y:2016:i:c:p:604-643
    DOI: 10.1016/j.jet.2016.02.012
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    More about this item

    Keywords

    Discretionary liquidity trading; Market liquidity; Information aggregation; Information production; Hedging;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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