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

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  • Katrin Tinn

    (London School of Economics)

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
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Katrin Tinn, 2005. "Optimal research in financial markets with heterogeneous private information; a rational expectations model," Money Macro and Finance (MMF) Research Group Conference 2005 6, Money Macro and Finance Research Group.
    • Handle: RePEc:mmf:mmfc05:6
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    References listed on IDEAS

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    1. Franklin Allen & Stephen Morris & Hyun Song Shin, 2003. "Beauty Contests, Bubbles and Iterated Expectations in Asset Markets," Cowles Foundation Discussion Papers 1406, Cowles Foundation for Research in Economics, Yale University.
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    More about this item

    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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