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Information acquisition in financial markets

In a recent article forthcoming in the American Economic Review, UC3M Business Jesper Rüdiger, and coauthor Adrien Vigier from the Norwegian Business School, explore information acquisition in dealer markets. We have asked the authors to comment on the paper's main findings:

"There are many ways to structure a financial market. The "dealer market" is one of them. In this type of market, a "dealer" (for instance a bank) acts as the intermediary for trades. This implies that buyers and sellers do not interact directly, but trade through the dealer. Roughly speaking, trading takes place as follows: the dealer posts the price at which you can buy the stock (the ask price) or sell the stock (the bid price); traders observe the quotes and decide whether to trade or not. Now think about the following problem: if it were possible to pay a moderate cost in order to learn a stock's true value, who would do so? On the one hand, traders want to acquire information about stocks to buy them if they are undervalued and sell them if they are overvalued. However, dealers also want to acquire information, in order to adjust the prices they post to the value of the stock.

In the paper we build a theoretical model to analyze the kind of situations described above. First, we show that in some situations the traders are the only ones to acquire information. However, in other situations, things are reversed: now it is the dealers who are the only ones to become informed. Second, we examine the impact of these findings on asset prices and find that, paradoxically, making information cheaper can have a negative impact on the functioning of the market, in the sense that prices end up being a poorer indicator of financial assets' fundamental values. Our hope is that, by shedding light on key mechanisms, our analysis can be useful for policy makers and empiricists."

The full article can be found at the following link: