Trading Costs and Informational Efficiency

Cecilia Parlatore and Eduardo Davila

No 494, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: Abstract This paper studies the effect of trading costs on information diffusion and information acquisition in financial markets. For a given precision of investors' private information, an irrelevance result emerges when investors are ex-ante identical: the level of trading costs does not affect price informativeness or price volatility. This result holds independently of whether investors behave competitively or strategically and applies to both static and dynamic economies. When investors are ex-ante heterogeneous, trading costs affect price informativeness if and only if investors who disproportionately trade on information are more elastic than investors who mostly trade due to hedging. Trading costs always reduce information acquisition, even when price informativeness remains unchanged for a given amount of information. Our results matter to understand a) the consequences of cheaper financial trading and b) the effects of transaction taxes.

Date: 2016
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Journal Article: Trading Costs and Informational Efficiency (2021)
Working Paper: Trading Costs and Informational Efficiency (2019)
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