Abstract
Higher market efficiency due to informed financial trading is typically considered to have positive feedback effects on the real economy. We extend the seminal Grossman-Stiglitz (1980) model to highlight an important negative feedback effect from trading to entrepreneurial activity: information revelation via prices leads to a clustering of risk at entrepreneurs. This distorts agents’ occupational choice between financial trading and entrepreneurship, discouraging real economic activity. This negative feedback effect provides explanations for excessive financial trading and multiplicity of equilibria.
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