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Optimal research in financial markets with heterogeneous private information: a rational expectations model

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  • Tinn, Katrin

Abstract

This paper investigates prices and endogenous research decision for financial assets. In rational expectations models with public information, higher order beliefs make investors to overweight the public information relative to underlying fundamentals. The extent of this mispricing is higher if the variance of private signals is relatively high. The model presented in this paper extends this setting by incorporating the research cost decision and endogenising the variance of the private signals that short-lived investors obtain in each period. It turns out that investors will be less willing to research in periods when there is an alternative asset with high return available. Furthermore, the optimal research decision will depend on the time left to the maturity of the asset. This explains, in a rational setting, why long lived assets like stocks may be priced based on the public information rather than research on fundamentals. JEL Classification: G12, G14

Suggested Citation

  • Tinn, Katrin, 2005. "Optimal research in financial markets with heterogeneous private information: a rational expectations model," Working Paper Series 493, European Central Bank.
    • Handle: RePEc:ecb:ecbwps:2005493
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    References listed on IDEAS

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    1. Philippe Bacchetta & Eric Van Wincoop, 2008. "Higher Order Expectations in Asset Pricing," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 40(5), pages 837-866, August.
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    More about this item

    Keywords

    Financial markets imperfections; heterogeneous information; research costs;
    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

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