Rational Information Choice in Financial Market Equilibrium∗

Information acquisition in financial markets is analyzed in an integrated model of information and portfolio choice. Asset returns are assumed to be gamma distributed and signals to be Poisson. A simultaneous rational expectations equilibrium in asset and information markets does exist under fully revealing prices. It entails a strictly positive amount of acquired signals if markets are large, asset returns relatively volatile or investors sufficiently risk averse. Thus, a long-standing noequilibrium paradox is resolved. More information reduces the ex ante variance of the asset return from each investor’s point of view, and thus allows for a better portfolio choice. A Samuelson-type welfare criterion for informational efficiency is proposed and applied. As with any public good, markets allocate information but less than socially desirable. However, the utility enhancing effect of more private information may be outweighed by the negative effect of its becoming commonly known. Information is reflected in the asset price. Shared information moves the price closer to the individually expected return, thus reducing the value of the risky asset. This can make information undesirable for investors. JEL G14, D81, D84 Theoretical and empirical assessments of financial markets and crises stress the importance of asymmetric information. However, they frequently take ∗I thank Maury Obstfeld, David Romer, Dan McFadden, Achim Wambach, Andy Rose, Bob Anderson, Chris Shannon, Sven Rady and Tom Rothenberg for insightful remarks. Seminar participants at University of Munich, City University Business School London, George Washington University, Deutsche Bundesbank and at ESEM 2002, Venice made helpful suggestions. A previous version of this paper circulated as “Another look at information acquisition under fully revealing asset prices.” ‡[email protected] (www.econ.ucsd.edu/muendler)