Abstract
I provide a channel by which information cost affects asset price volatility. Asset payoffs depend on two exogenous states, an unknown state about which buyers obtain costly information and a known state at the time of trading. Whereas the price of an asset with a higher information cost shows less sensitivity in response to changes in an unknown state, the asset price exhibits excess volatility in response to a known shock. This can explain how a small liquidty shock causes large fluctuations in asset markets.
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