Optimal Financial Nä ı veté

When agents first become active investors in financial markets, they are relatively inexperienced. Much of the literature focuses on the incentives of presumably sophisticated informed agents to produce information, and not on the na¨ıve agents. However , unsophisticated agents are important aspects of financial markets and worth analyzing further. In this paper, we provide a theoretical perspective that addresses the issue of how many na¨ıve traders would one expect in a financial market where policy makers try to educate the na¨ıve agents. We show that such policy trades off the effects of na¨ıve trades on price efficiency versus the losses incurred by these traders in financial markets. The optimal proportion of na¨ıve agents varies with the value of information, the noise in private signals, and the inherent sensitivity of corporate investment to prices. We also show that the policy tool of encouraging insider trading can deter na¨ıve investors and thus improve corporate governance and the efficacy of corporate investment.