Attention constraint, public information, and strategic trading

Abstract

We investigate the effect of institutional investor attention and the public information about asset value on the financial market by studying a strategic trading problem, where the strategic trader is subject to an information-processing constraint and the asset value follows a mean-reverting process. We show that the limited institutional investor attention endogenously generates a private signal for the strategic trader, precluding a fully revealed price. In contrast, the transparency of the asset value improves the market efficiency. Furthermore, the trading aggressiveness, expected payoff, and informativeness of price increase with institutional investor attention, while market liquidity decreases with this attention. On the other hand, the effect of the public information about asset value is uncertain and depends on the remaining of the strategic trader's information advantage. This feature explains different empirical findings pertaining to the relationship between public news and market liquidity.