EconPapers    
Economics at your fingertips  
 

Informed Trading, Investment, and Welfare

Rohit Rahi () and James Dow

FMG Discussion Papers from Financial Markets Group

Abstract: This paper studies the welfare economics of informed trading in a stock market. We provide a model in which all agents are rational and trade either to exploit information or to hedge risk. We analyze the effect of more informative prices on investment, given that this dependence will itself be reflected in equilibrium prices. Agents understand that asset prices may affect corporate investment decisions, and condition their trades on prices. We present both a general framework, and a parametric version that allows a closed-form solution. We show that in rational expectations equilibrium with price-taking competitive behaviour, and in the presence of risk-neutral uninformed agents, uninformed traders cannot lose money on average to informed traders. However, some agents with superior information may be willing to lose money on average, in order to improve their hedging possibilities. While a higher incidence of informed speculation always increases firm value through a more informative trading process, the effect on agents welfare depends on how revelation of information that agents wish to insure against reduces their hedging opportunities (the Hirshleifer effect). On the other hand, early revelation of information that is uncorrelated with hedging needs allows agents to construct better hedges.

Date: 1998-04
References: Add references at CitEc
Citations: View citations in EconPapers (55)

Downloads: (external link)
http://www.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp292.pdf (application/pdf)

Related works:
Journal Article: Informed Trading, Investment, and Welfare (2003) Downloads
Working Paper: Informed Trading, Investment, and Welfare (1997)
Working Paper: Informed Trading, Investment and Welfare (1996)
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:fmg:fmgdps:dp292

Access Statistics for this paper

More papers in FMG Discussion Papers from Financial Markets Group
Bibliographic data for series maintained by The FMG Administration ().

 
Page updated 2024-07-23
Handle: RePEc:fmg:fmgdps:dp292