Informational and Allocative Efficiency in Financial Markets with Costly Information

Arina Nikandrova
Additional contact information
Arina Nikandrova: Department of Economics, Mathematics & Statistics, Birkbeck

No 1403, Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics

Abstract: Costly information acquisition is introduced into a dynamic trading model of Glosten and Milgrom (1985). The market maker and some traders, called "value traders," value the asset at its fundamental value, which can be either high or low. The remaining traders, called "liquidity traders," have idiosyncratic valuations that are independent of the fundamental. At a cost, each value trader can acquire an informative, but imperfect, signal about the fundamental. In this setting, at equilibrium, each value trader acquires the signal if and only if the uncertainty about the fundamental's value conditional on publicly available information is sufficiently high. Thus, the prices quoted by the market maker are "informationally inefficient," as they do not reveal the value of the fundamental, even in the long-run. Equilibrium amount of information acquisition is either excessive or insufficient relative to the social optimum and results in an inefficient allocation of the asset among the market maker and liquidity traders.

Keywords: Sequential Trading; Cost of Information; Endogenous Information Acquisition. (search for similar items in EconPapers)
JEL-codes: D80 D83 D84 G12 G14 (search for similar items in EconPapers)
Date: 2014-03
New Economics Papers: this item is included in nep-cta, nep-fmk, nep-ger and nep-mst
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
https://eprints.bbk.ac.uk/id/eprint/15282/1/15282.pdf First version, 2014 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bbk:bbkefp:1403

Ordering information: This working paper can be ordered from

Access Statistics for this paper

More papers in Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics Malet Street, London WC1E 7HX, UK.
Bibliographic data for series maintained by ( this e-mail address is bad, please contact ).