Information, Imperfect Competition, and Volatility

Abstract

An important consideration in informed trading is to explicitly take into account the effects of trades on asset prices. In this paper we develop a general equilibrium model of information acquisition and asset pricing under imperfect competition. We show that if investors are sufficiently risk averse, imperfect competition reduces their incentives to acquire information and the reduction may lead to significant illiquidity and price volatility in the market. The negative strategic value of information is the source of illiquidity and price volatility. Episodes of significant illiquidity occur in an environment in which the equilibrium information asymmetry is low. In contrast to the perfect competition model, we show that in the imperfect competition model there is generally strategic complementarity in investors' information acquisition decisions.