Endogenous Information Research Articles

How is Information (Under-) Valued? Evidence from Framed Field Experiments

Rational endogenous information acquisition plays a key role in many economic models. This assumption may be violated, however, if agents are overconfident about their knowledge. In a novel field experiment, businesspeople experts made guesses about the price and quality of actual websites. They then had the opportunity to purchase information to improve their guesses. I find that experts exhibit significant overconfidence and that overconfidence is associated with a lower demand for information. On average, experts significantly underpay for information. However, overconfidence is unlikely to provide a full explanation for suboptimal information investment. Even if the value of information is adjusted to account for subjects’ overconfidence or subjects’ tendency to sometimes misuse information, subjects still underpay for information.

Learning, Active Investors, and the Returns of Financially Distressed Firms

I develop a dynamic asset pricing model to analyze expected returns of financially distressed firms in the presence of learning about firm fundamentals and endogenous information acquisition by active investors that acquire large stakes in distressed firms via private investments in public equity. The model reveals that learning and information acquisition critically affect risk exposures close to default and can rationalize low and even negative expected equity returns for firms with high default risk. Similar to Schumpeter’s (1934) argument that recessions have a positive, cleansing effect on the economy, the model reveals that equity holders may benefit from the increased speed of learning about insolvent firms in downturns, which increases the value of their abandonment option in these times. Equity holders’ option value is further enhanced by the ability to partially free-ride on active investors’ acquisition of information on firm fundamentals. Both information channels are shown to affect equity betas, and may account for striking, momentum-type dynamics in risk premia.

Endogenous Information Asymmetry and Portfolio Bias

Endogenous Information Asymmetry and Portfolio Bias

Contracting under Incomplete Information and Social Preferences: An Experimental Study

Principal-agent models in which the agent has access to private information before a contract is signed are a cornerstone of contract theory. We have conducted an experiment with 720 participants to explore whether the theoretical insights are reflected by the behavior of subjects in the laboratory and to what extent deviations from standard theory can be explained by social preferences. Investigating settings with both exogenous and endogenous information structures, we find that agency theory is indeed useful to qualitatively predict how variations in the degree of uncertainty affect subjects' behavior. Regarding the quantitative deviations from standard predictions, our analysis based on several control treatments and quantal response estimations shows that agents' behavior can be explained by social preferences that are less pronounced than in conventional ultimatum games. Principals' own social preferences are not an important determinant of their behavior. However, when the principals make contract offers, they anticipate that social preferences affect agents' behavior.

Noise and aggregation of information in large markets

We study the relation between noise (liquidity traders, endowment shocks) and the aggregation of information in financial markets with large number of agents. We show that as long as noise increases with the number of agents, the limiting equilibrium is well-defined and leads to non-trivial information acquisition, even when per-capita noise tends to zero. In such equilibrium risk sharing and price revelation play different roles than in the standard limiting economy in which per-capita noise is finite. We apply our model to study information sales by a monopolist, and information acquisition in multi-asset markets, showing that it leads to qualitatively different results with respect to those in the existing literature. Our conditions on noise are shown to be necessary and sufficient to have limiting economies with perfectly competitive behavior consistent with endogenous information acquisition.

Informação Endógena, Caracterização do Risco e Retornos de Ações Variantes no Tempo

Neste artigo, oferecemos um novo tipo de caracterização do risco da previsibilidade de dois conhecidos padrões anormais dos retornos médios das ações: momento e reversões. O objetivo é ilustrar a importância relativa dos fatores comuns de risco e da informação endógena para explicar a variabilidade no tempo dos retornos de momento e reversão. Nossos resultados demonstram que, mesmo na presença de carteiras de investimento nulo, os spreads dos retornos médios de momento e reversão correspondem aos spreads dos coeficientes angulares da informação endógena. Os resultados empíricos corroboram a perspectiva de que várias classes de empresas reagem de forma diferente ao risco de volatilidade e, tanto o tamanho quanto a relação valor patrimonial - valor de mercado da ação médios das empresas, contém, em conjunto, importantes fontes de risco potencial. Tomados em conjunto, nossos resultados sugerem que os retornos são influenciados pelo fluxo endógeno de informações aleatórias, que é assimétrico por natureza e que pode ser usado como fator de atribuição de desempenho. Quando não se incorporam as informações endógenas assimétricas existentes, escondidas no comportamento histórico, qualquer tentativa de explorar a previsibilidade da média do retorno das ações estará sujeita a um viés de especificação não quantificado.

The Asymmetric Effects of Financial Frictions

Economic variables move asymmetrically over the business cycle: quickly during crises but slowly during recoveries. I show that this asymmetry is stronger in countries with less developed financial systems and greater financial frictions. Then I explain this fact using a learning model with endogenous information about economic conditions. Financial frictions, which I capture by higher bankruptcy costs, magnify the reaction of lending rates and economic activity to negative shocks and then delay their recovery by restricting information after the crisis. Empirical evidence and a quantitative exploration of the model show that this explanation is consistent with the data.

Wholesale-price contract of supply chain with information gathering

This paper investigates a wholesale-price contract of supply chain under the endogenous information structure. This supply chain consists of one supplier and one retailer during the selling season. The retailer does not know his selling cost but can spend resources to acquire information. The supplier offers a contract, which induces the retailer to gather information and generate more production orders with beta costs. We find that there exists an upper bound of the information gathering cost such that the supplier induces the retailer to gather information. The increasing cost of information gathering may decrease the order quantity and wholesale price. Moreover, the cost beta has an impact on the expected profits of the two parties. With the increasing cost of information gathering, the supplier’s expected profit is reduced, while that of the retailer becomes ambiguous in terms of the distribution function and the interval of selling cost information. Finally, a numerical example is presented to explain the main results.

Endogenous information and stochastic contracts

A growing literature analyzes revenue-maximizing contracts for situations in which agents can acquire private information before they decide whether to join the contract. It is conjectured that the results also apply to the more natural scenario where information can be acquired either before or after signing. This paper shows that, in fact, the latter scenario is more favorable for the principal. Using stochastic contracts, she can induce information acquisition with some probability and yet appropriate the generated surplus.

Social Learning Through Endogenous Information Acquisition: An Experiment

This paper provides a test of a theory of social learning through endogenous information acquisition. A group of subjects face a decision problem under uncertainty. Subjects are endowed with private information about the fundamentals of the problem and make decisions sequentially. The key feature of the experiment is that subjects can observe the decisions of predecessors by forming links at a cost. The model predicts that the average welfare is enhanced in the presence of a small cost. Our experimental results support this prediction. When the informativeness of signals changes across treatments, behavior changes in accordance with the theory. However, within treatments, there are important deviations from rationality such as a tendency to conform and excessive link formation. Given these biases, our results indicate that subjects would, except when faced with a small cost, have been better off not forming any links. This paper was accepted by Teck Ho, behavioral economics.

The Corporate Governance Role of Information Quality and Corporate Takeovers

We examine the corporate governance roles of firms' information quality and the takeover market in disciplining management. Increasing the information quality improves the takeover efficiency, but highly efficient takeover market also discourages the manager from working hard. We find that perfect information quality is not optimal for either the current shareholders' expected payoff maximization or the expected firm value maximization. The current shareholders' choice of information quality is different from the information quality level that maximizes the expected firm value, as the current shareholders only obtain a share of the value enhancement from a successful takeover, and moreover, the current shareholders also obtain an overbidding premium when the acquirer overbids for a low value firm. We also analyze the impact of antitakeover laws on firms' endogenous information quality as well as on the current shareholders' welfare and the firm value. We find that the expected firm value may increase after the adoption of antitakeover laws when the current shareholders are able to adjust their choice of information quality. This happens when the current shareholders increase the information quality in response to antitakeover laws.

Inequality, Intergenerational Mobility and Redistributive Policies under Endogenous Information

This paper presents a dynamic model to study how different levels of information about the root determinants of wealth (luck versus effort) can impact inequality and intergenerational mobility through societal beliefs, individual choices and redistributive policies. To my knowledge, the model presented is the first dynamic model in which skills are stochastic and both beliefs and voted redistribution are determined endogenously. The model is able to explain a number of empirical facts. Large empirical evidence shows that the difference in the political support for redistribution appears to reflect differences in the social perceptions regarding the determinants of individual wealth and the underlying sources of income inequality. Moreover the beliefs about the determinants of wealth impact individual choices of effort and therefore the beliefs about the determinants of wealth impact inequality and mobility both through choices of effort and redistributive policies. The model generates multiple equilibria (US versus Europe-type) which may account for the observed features not only in terms of societal beliefs and redistribution but also in terms of perceived versus real mobility and inequality.

Information Exchange in Prediction Markets: How Social Networks Promote Forecast Efficiency

This paper studies the effects of information exchange and social networks on the performance of prediction markets with endogenous information acquisition. We provide a game-theoretic framework to resolve the question: Can social networks and information exchange promote the forecast efficiency in prediction markets? Our study shows that a social network is not a panacea in terms of improving forecast efficiency. The use of social networks could be detrimental to forecast performance when the cost of information acquisition is high. Although social networks can provide internal communications among participants, they reduce the incentive to acquire information because of free riding. We also study the effects of social networks on information acquisition in prediction markets. In the symmetric Bayes-Nash Equilibrium, all participants use a threshold strategy, and the equilibrium action of information acquisition is decreasing in the number of participant's friends and increasing in the network density. The aforementioned results are robust to two commonly used mechanisms of prediction markets: a forecast-report mechanism and a security-trading mechanism.

Reputational Concern with Endogenous Information Acquisition

We develop a reputational cheap talk model to characterize the essential activities of an expert: information acquisition and information transmission. The decision maker, who has the authority to take actions, is in lack of relevant information and is uncertain about the expert's preference. The expert, who acquires and conveys information, may be biased that he is in favor of a particular action, or may be aligned that he cares about the decision maker's payoand has reputational concern. Our main insight shows that an aligned expert's reputational concern may have a non-monotonic eect on his information acquisition incentive: he acquires better information if and only if his reputational concern is moderate. Another main insight describes that the possible existence of biased experts may actually increase the decision maker's payoand social surplus, which diers from Stephen Morris (2001), Ely and Valimaki (2003) and Ely, Fudenberg and Levine (2008) substantially. Regarding delegation, unlike the result in Aghion and Tirole (1997), we show that delegation may reduce the aligned expert's information acquisition incentive. Finally, our analysis illustrates that the decision maker prefers communication to delegation whenever informative communication is feasible, which is opposite to Wouter Dessein (2002).

Combining recombineering and ends-out homologous recombination to systematically characterize Drosophila gene families

Evaluating how an individual gene contributes to a particular biological process benefits greatly from a comprehensive understanding of all members of its gene family. Such knowledge is ideally obtained using multicellular model organisms, which provide rapid and decisive platforms for determining gene function. We recently established a novel transgenesis platform in Drosophila to systematically knock out all members of the Rab small GTPase family of membrane regulators. This platform combines BAC transgenesis/recombineering with ends-out homologous recombinations and GatewayTM technologies and provides a new rapid and scalable method that eases the manipulation of endogenous loci. This method not only allows for the generation of molecularly defined lesions, but also the precise replacement or tagging of genes in their endogenous loci. Using this method, we found that up to half of all Rab GTPases exhibit enriched expression at synapses in the nervous system. Here we provide critical details about the underlying recombineering and transgenesis method, new cassettes for tagging endogenous loci and information on important parameters that will allow Drosophila researchers to target members of other gene families.

Endogenous Information Asymmetry and Portfolio Bias

Endogenous Information Asymmetry and Portfolio Bias

A Citizen-Editors Model of News Media

This paper provides a model of the market for news where profit-maximizing media outlets choose their editors from a population of rational citizens. The analysis identifies a novel mechanism of media bias: the bias in a media outlet's news reports is the result of the slanted endogenous information acquisition strategy of its editor. In particular, the results show that the expected accuracy of news reports is lower the more ideological an editor is. Nevertheless, citizens find it optimal to acquire information from a media outlet whose editor has similar ideological preferences. Depending on the distribution of citizens' ideological preferences, a media outlet may choose an ideological editor even in a monopolistic market. Moreover, ideological editors are more likely to be present in the market for news: i) the higher the number of media outlets competing in the market for news; ii) the lower the opportunity cost that citizens have to incur to acquire information.

Endogenous Liquidity Cycles

This paper presents a theory of liquidity cycles based on endogenous uctuations in economic activity and the availability of informed capital. Risky assets are illiquid due to adverse selection. The degree of adverse selection and hence the liquidity of these assets depends on the endogenous information structure in the market. Liquidity provision is modeled as a repeated game with imperfect public monitoring. We construct a triggerstrategy equilibrium along the lines of Green and Porter (1984) that is characterized by stochastic uctuations in liquidity. Liquidity is procyclical in our economy. Periods of economic growth are associated with more liquid asset markets. However, unlike other explanations in the literature, our results do not rely on exogenous shocks to the economy. Rather, uctuations in liquidity arise endogenously from the need to create incentives for

The Double-Entry Constraint in Econometric Estimation

The key proposition of the paper lies in the treatment of financial statements as a matrix of endogenous information codetermined by double entry. To account for the highly structured information set in econometric estimation, we develop a generalised structural system for use with accounting variables, within which the deterministic relationships governing financial statement articulation are clearly defined. The framework is used to formulate fully identified models that are consistent with the underlying duality that characterises the generating process of accounting data. To demonstrate the efficacy of the approach, we consider the model of equity pricing in Penman and Yehuda (2009), and the model of investment sensitivity to operating cash flow in Fazzari, Hubbart and Petersen (1988) and Kaplan and Zingales (1997). By comparison with the more traditional estimation methods, the structural system is shown to yield estimates with increased precision that adhere to double entry rules.

Capital Structure Efficiency, Information Quality, and Accounting Biases

In this paper, we investigate the effect of accounting biases on firms' financing decisions and the role of accounting biases in endogenous information quality. We show that in industries with generally low-profit prospects, a downward-biased accounting system performs better than a neutral accounting system, and a more downward bias helps mitigate both investment and financing inefficiency; while for industries with generally high-profit prospects, an upward-biased accounting system is better than a neutral accounting system, and a more upward bias helps improve financing efficiency. In addition, we find that a more downward-biased accounting system motivates good firms to exert more effort to improve the information quality, which improves overall efficiency.