Abstract
I present an asymmetric information model of financial markets in which there
is uncertainty and learning not only about fundamentals but also about the proportion
of informed-to-noise traders in the market. Extreme news leads to an increase
in both types of uncertainty, while it decreases price informativeness. Uncertainty
about the market composition constitutes a type of liquidity risk and is associated
with high expected returns. The resulting price-volume relationship is U-shaped and
positively sloped. In a dynamic extension of the model I show that this mechanism
generates momentum as well as history-dependent volatility and price informativeness.
is uncertainty and learning not only about fundamentals but also about the proportion
of informed-to-noise traders in the market. Extreme news leads to an increase
in both types of uncertainty, while it decreases price informativeness. Uncertainty
about the market composition constitutes a type of liquidity risk and is associated
with high expected returns. The resulting price-volume relationship is U-shaped and
positively sloped. In a dynamic extension of the model I show that this mechanism
generates momentum as well as history-dependent volatility and price informativeness.
| Original language | English |
|---|---|
| Journal | Financial Review |
| Volume | 58 |
| Issue number | 2 |
| Publication status | Accepted/In press - 6 Dec 2022 |