Working Paper: CEPR ID: DP6588
Authors: Rui Albuquerque; Jianjun Miao
Abstract: This paper provides a dynamic rational expectations equilibrium model in which investors have heterogeneous information and investment opportunities. Informed investors privately receive advance information that is useful for predicting future earnings, but is unrelated to current earnings. This information is immediately partially incorporated into stock prices. In response to good advance information, informed investors act as trend chasers and raise investments in both stocks and nontraded assets, leading them to bear more aggregate risk. This raises the expected risk premium and generates short-run momentum. Uninformed investors act as contrarians and sell stocks. When the advance information materializes in the future, excess returns fall, generating long-run reversals.
Keywords: advance information; momentum; reversal effect; rational expectations equilibrium
JEL Codes: G11; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| advance information (Y20) | increased investment in stocks and non-traded assets (G19) |
| increased investment in stocks and non-traded assets (G19) | higher expected excess returns (G12) |
| informed investors' speculative behavior (D84) | uninformed investors' reactions (G41) |
| uninformed investors' reactions (G41) | decline in excess returns (G14) |
| advance information (Y20) | short-run momentum (E32) |
| persistence of private investment returns (G31) | serial correlation of excess returns (C22) |
| advance information (Y20) | market dynamics (D49) |