Working Paper: CEPR ID: DP9291
Authors: Elias Albagli; Christian Hellwig; Aleh Tsyvinski
Abstract: With only minimal restrictions on security payoffs and trader preferences, noisy aggregation of heterogeneous information drives a systematic wedge between the impact of fundamentals on the price of a security, and the corresponding impact on cash flow expectations. From an ex ante perspective, this information aggregation wedge leads to a systematic gap between an asset's expected price and its expected dividend. The sign and magnitude of this expected wedge depend on the asymmetry between upside and downside payoff risks and on the importance of information heterogeneity. We consider three applications of our theory. We first show that predictions of our model provide a novel theoretical justification and are quantitatively consistent with documented empirical regularities on negative relationship between returns and skewness. Second, we illustrate how heterogeneous information leads to systematic departures from the Modigliani-Miller theorem and provide a new theory of debt versus equity. Third, we provide conditions under which permanent over- or under-pricing of assets is sustainable in a dynamic version of our model.
Keywords: asset prices; information aggregation; Modigliani-Miller theorem; skewness
JEL Codes: D82; D84; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| noisy aggregation of heterogeneous information (D80) | information aggregation wedge (C43) |
| information aggregation wedge (C43) | systematic gap between equilibrium price and expected dividends (G19) |
| asymmetry of payoff risks (D81) | expected price (D41) |
| information heterogeneity (D83) | expected price (D41) |
| higher skewness (C46) | lower returns (G19) |
| heterogeneous information (D89) | departures from Modigliani-Miller theorem (G19) |
| information structure (L15) | design of financial securities (G12) |
| expectation of future price movements (D84) | current pricing behavior (D40) |
| certain conditions (C62) | securities may be permanently over or underpriced (G12) |