Report

Teaser, summary, work performed and final results

Periodic Reporting for period 2 - Endogenous_Info (Financial Decision Making with Endogenous Information Acquisition)

Teaser

The project aims to understand the process of endogenous information acquisition in financial markets. Information choices are at the front of any decision making so understanding this process is of great importance to society overall. The project explores various settings of...

Summary

The project aims to understand the process of endogenous information acquisition in financial markets. Information choices are at the front of any decision making so understanding this process is of great importance to society overall. The project explores various settings of the problem from both theory and empirical perspectives. In a standard decision framework, economic agents update their beliefs based on information (signals) they acquire. While this framework is elegant and provides a solid foundation for our economic thinking, testing it directly poses a formidable task. A major problem is that information choices are not observable and, therefore, most information-based models in finance take information as an exogenous “black box”. Another problem is that information choice models with many assets and heterogeneously informed agents are generally difficult to solve and test. A few sparse contributions in financial economics either assume a simple information structure with two types of agents, informed and uninformed, (Van Nieuwerburgh and Veldkamp, 2009, 2010; Kacperczyk, van Nieuwerburgh, and Veldkamp, 2015) or they solve problems with one risky and riskless asset (Peress, 2004).

My ERC CoG project aims to endogenize information choices in rich economic structures. These projects identify new ways to model information choices with heterogeneously informed agents and heterogeneous assets in a general equilibrium framework. They show how to match predictions of such models with the data not only qualitatively but also quantitatively. Further, they illustrate ways in which the market structure affects information choices. Finally, they provide empirical micro-foundations for information acquisition and processing in financial markets.

Providing micro-foundations for information and its endogenous acquisition is of first-order importance. From the perspective of academic research, we want to understand causal mechanisms that drive economic decisions. The framework in which information is not micro-founded makes it difficult to distill such causality. Establishing causal links in economic data is further important for policy design and its effectiveness. It makes it also possible to take existing modeling paradigms to address questions beyond the narrow modeling framework. The projects in the proposal are among the first to take the literature in this direction both theoretically and empirically. They also study more realistic contexts in which we observe rich heterogeneity both in terms of agents’ information and assets in which they can invest.

Work performed

Over the reporting period, the project has been advanced along several dimensions. Below, I summarize the major steps that have been completed since the beginning period.

1. The project “Investor Sophistication and Capital Income Inequality” has been completed and accepted for publication at the Journal of Monetary Economics. The paper has already attracted a good number of citations and I believe it will continue on that path.

2. The project “Market Power and Price Informativeness” is still a work in progress. In the process of collecting feedback from conferences I have learnt about alternative approaches to address the problem related to demand schedules. I am in the process of completing the second draft of the paper, which I would then send immediately for publication.

3. I have completed a major part of the theoretical component linking market power of traders to market efficiency. The model is now quite rich and delivers novel predictions regarding the role of active and passive investors in welfare formation and market efficiency.

4. I have extended the price informativeness framework into an empirical work on the role of globalization in financial markets. The project has recently received positive feedback from the Review of Financial Studies and I am preparing the new draft for the resubmission to the journal.

Final results

\"The big benefit of preparing the new draft of the project \"\"Market Power and Price Informativeness\"\" will be that the oligopolists are now going to internalize learning from each other unlike in the previous Cournot-type approach. I particularly happy with how the revision process proceeded on this paper. This is a true example of the ERC project, a high risk, high reward project that gets shaped into a really good contribution.

The project on insider trading moves significantly our understanding of how informed investors trade and how they take into consideration legal risk associated with their trading. I have now generated a novel theoretical framework that illustrates how agents trade off the risk of losing information against the risk of legal enforcement from the perspective of their trading decision.

The project on globalization and capital market efficiency is taking a significant step to understand the role of globalization at the micro-level, both individually and at the firm level. The data and the framework are very conducive to this kind of exercise and I hope the project will improve our understanding of the role of globalization in society.\"

Website & more info

More info: http://www.kacperczyk.net.