Working Paper: CEPR ID: DP13278
Authors: Laura Veldkamp; Maryam Farboodi
Abstract: “Big data” financial technology raises concerns about market inefficiency. A common concern is that the technology might induce traders to extract others’ information, rather than produce information themselves. We allow agents to choose how much to learn about future asset values or about others’ demands, and explore how improvements in data processing shape these information choices, trading strategies and market outcomes. Our main insight is that unbiased technological change can explain a market-wide shift in data collection and trading strategies. However, in the long run, as data processing technology becomes more and more advanced, both types of data continue to be processed. What keeps the data economy in balance is two competing forces: Data resolves investment risk, but future data creates risk. The efficiency results that follow from these competing forces upend common wisdom. They offer a new take on what makes prices informative and whether trades typically deemed liquidity-providing actually make markets more resilient.
Keywords: fintech; big data; financial analysis; liquidity; information acquisition; growth
JEL Codes: G14; E2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| unbiased technological change (O33) | market-wide shift in data collection and trading strategies (G14) |
| improvements in data processing (C80) | better forecasting of asset payoffs (G17) |
| better forecasting of asset payoffs (G17) | reduction in investment risk (G11) |
| future data processing (C89) | new risks (D81) |
| increased price informativeness (D41) | enhanced liquidity (G19) |
| demand-driven trading strategies (C69) | market liquidity stagnation (E44) |
| shift from fundamental analysis to demand analysis (D12) | price informativeness increase (G14) |
| static risk reduction vs dynamic risk creation (J28) | governs long-run market liquidity and information choices (G19) |