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Asymmetric information, heterogeneous prior beliefs, and public information

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  • Gong, Fuzhou
  • Liu, Hong

Abstract

We present a dynamic trading model that assumes traders face not only asymmetric information but also heterogeneous prior beliefs under a mandatory public disclosure requirement. We find that the overconfident insider chooses to trade in an alternating way in the sense that he underreacts to his information in the first period, overreacts in the second, underreacts in the third, overreacts in the fourth, and so on. The irrational insider trades in this way not only to dissimulate his information but also to equalize his profits across periods. The coexistence of public disclosure and heterogeneous prior beliefs leads to large and fluctuant trading volumes, and the more underconfident the insider is, the greater is the degree of fluctuation. Also, contrarian and momentum trading arise endogenously as a result of the insider's irrationality and the public disclosure. Finally, we present the economic explanation for our model by giving the Granger causality relationship between the amended price series and the insider's trading order series.

Suggested Citation

  • Gong, Fuzhou & Liu, Hong, 2016. "Asymmetric information, heterogeneous prior beliefs, and public information," International Review of Economics & Finance, Elsevier, vol. 46(C), pages 100-120.
    • Handle: RePEc:eee:reveco:v:46:y:2016:i:c:p:100-120
    DOI: 10.1016/j.iref.2016.07.005
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    More about this item

    Keywords

    Public disclosure; Insider trading; Price discovery; Heterogeneous prior beliefs; Granger causality;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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