Active Investment, Liquidity Externalities, and Markets for Information

Informed investors are a source of illiquidity, but those pursuing di¤erently informed strategies also generate quasi -noise trading. Quasi-noise trading creates non-monotonic externalities in information choice that shape the composition of active investment and that in‡uence investor herding, liquidity spirals, asset comovement, along with the information content of prices. These externalities also a¤ect information markets. An information vendor with market power expands sales only to monopolize investor attention, which can make prices less informative. By contrast, vendor competition boosts quasi-noise trading, which promotes investor diversity. Finally, selling information can be a means to create liquidity for proprietary trades. Keywords: Market liquidity, noise trading, information acquisition, information market I thank Philippe Aghion, Ulf Axelson, Mike Burkart, Sabrina Buti, Douglas Diamond, Mike Fishman, Thierry Foucault, Larry Glosten, Ludovic Phallipou, Petra Persson, Tarun Ramadorai, Per Strömberg, Matti Suominen, Stijn van Nieuwerburgh, and Laura Veldkamp for comments and discussions. I also thank conference participants at the European Finance Association Meetings 2008 and the European Econometric Society Winter Meetings 2008, and seminar participants at Berkeley, Columbia, Chicago, McGill, MIT, Northwestern, NYU, Ohio State University, University of Amsterdam, and Wharton. I am grateful for …nancial support from the European Corporate Governance Training Network and the Jan Wallander Foundation.