Working Paper: CEPR ID: DP17025
Authors: Alessandro Pavan; Savitar Sundaresan; Xavier Vives
Abstract: We study inefficiency in the acquisition of private information before trading in financial markets. As the cost of information declines, traders over-invest in information acquisition and trade too much on their private information. Generically, no policy exists based on the price of the financial asset and the individual trade volume inducing efficiency in both information acquisition and trading. Such an impossibility result turns into a possibility one when information acquisition is verifiable or when taxes can be made contingent on the aggregate volume of trade. When only ad-valorem taxes are available, they should not be used.
Keywords: information acquisition; aggregation through prices; information externalities; team efficiency
JEL Codes: D84; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inefficiencies in information acquisition and trading (D83) | interaction of learning and pecuniary externalities (D29) |
| traders collect private information (D82) | overinvest or underinvest based on prevailing market conditions (G11) |
| equilibrium demand schedules are downward sloping (D59) | overresponding to private signals (G41) |
| equilibrium demand schedules are upward sloping (D59) | underresponding to private signals (D82) |
| verifiability of information acquisition (D83) | efficiency can be induced through taxation policies (H21) |
| non-verifiability of information acquisition (D83) | efficiency can be achieved by conditioning the marginal tax rate on the aggregate volume of trade (H21) |