Equilibrium price with institutional investors and with naive traders

This paper uses an equilibrium model to study how institutional investors in uence the volatility and the informativeness of asset prices. The growth in the proportion of U.S. equities owned by institutions in the past two decades, their resulting dominant position in nancial markets, and empirical evidence that institutional ownership may increase volatility warrant studying this issue from a theoretical standpoint. In this paper, institutional investors are assumed to be \rational" informed traders while individual investors are supposed to be \naive" informed traders, insofar as the former use the equilibrium price to extract information while the latter do not. Using a framework with a competitive market, multiple informed traders and one liquidity trader, the paper compares the informativeness and the volatility of the equilibrium price in an economy where the informed traders are naive and in one where they are rational. The model also studies how the informativeness and the volatility of the price react to changes in parameters such as the quality of the information of the informed traders, their aversion to risk, the variance of the true asset price, etc. The paper nally investigates how an increase in the number of informed traders, whether they are rational or naive, a ects the price variance, and assesses the impact of transaction costs on the variance of the price and its informativeness.