How does the diversity of investors’ beliefs affect stock price informativeness?

Abstract

ABSTRACTA growing number of studies have investigated the role of stock prices in aggregating private information and guiding resource reallocation. However, this article may be the first attempt to study how the diversity of beliefs affects stock price informativeness. The framework of the noisy rational expectations model shows that stock informativeness is determined by both the precision and use of private information in trading. If private beliefs about the value are highly diverse, the aggregate average opinion revealed in a stock’s price will be more accurate and, thus, more informative. As the price becomes more informative, however, individual investors will rely less on their private information. When this occurs, less private information will be absorbed in price, which, in turn, reduces price informativeness. Our model shows that the relationship between belief diversity and price informativeness is U-shaped in equilibrium.