Working Paper: CEPR ID: DP7180
Authors: Bryan Kelly; Alexander P. Ljungqvist
Abstract: Theoretical asset pricing models routinely assume that investors have heterogeneous information. We provide direct evidence of the importance of information asymmetry for asset prices and investor demands using plausibly exogenous variation in the supply of information caused by the closure or restructuring of brokerage firms' research operations. Consistent with predictions derived from a Grossman and Stiglitz-type model, share prices and uninformed investors' demands fall as information asymmetry increases. Cross-sectional tests support the comparative statics. Prices and uninformed demand experience larger declines, the more investors are uninformed, the larger and more variable is turnover, the more uncertain is the asset's payoff, and the noisier is the better-informed investors' signal. We show that prices fall because expected returns become more sensitive to a liquidity-risk factor. Our results imply that information asymmetry has a substantial effect on asset prices and that a primary channel linking asymmetry to prices is liquidity.
Keywords: Analyst Coverage; Asymmetric Information; Asset Pricing; Liquidity
JEL Codes: G12; G14; G17; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| coverage termination by brokerage firms (G24) | increase in information asymmetry (D82) |
| increase in information asymmetry (D82) | decline in share prices (G10) |
| increase in information asymmetry (D82) | decline in demand from uninformed investors (G19) |
| greater information asymmetry (D82) | greater sensitivity of expected returns to liquidity risk factors (G19) |
| greater turnover and uncertainty regarding asset's payoff (G19) | more pronounced declines in prices and uninformed demand (D89) |
| increase in information asymmetry (D82) | increase in loading on liquidity risk factor (F65) |