Information Communication in Financial Markets∗

Empirical evidence shows word-of-mouth communication has real effects on trading patterns in financial markets. On top of that, the social network through which the information conveys also plays a crucial role. We propose a framework that allows informed traders to directly and truthfully communicate information in four major social interaction structures represented by circle, tree, star and complete network graphs. In particular, we generalize à la Kyle (1985)’s strategical noisy rational expectation model by incorporating directed information transmission. We highlight that individual exploits information distinctly in different networks, and individual’s influence on market price relies on the network type and position in the network. Despite of the distinction on individual trading behavior and influential power on price, market trading patterns are similar irrespective of the network structures. Trading volume, price volatility and the information efficiency of price are all higher in networks than their counterparts in conventional models without networks.