Informational Frictions in Financial Markets

Informational Frictions in Financial Markets

Funder: European Commission

Principal Investigator: Professor Marcin Kacperczyk

Duration: April 2014 – March 2018

Are financial markets informationally efficient, what is the importance of information frictions for asset prices and corporate decisions, are some investors more informed than others and what are their sources of private information? These questions, undoubtedly of great economic significance, have permeated academic and professional circles in recent decades. Despite significant progress on both the theoretical and empirical fronts there still remain many questions, the answers to which would enhance our understanding of the financial and economic worlds. This project considers the micro-foundations for informed trading in both investment and corporate settings using the context of illegal insider trading and investigates the macro implications for the evolution of wealth and income across economic agents, with a particular emphasis on the growing disparity between rich and poor.

The first part of this research looks at informed trading among agents who are passed secret information that gives them an advantage over other market participants known as insider trading. This project will consider:

  • Do existing measures of informed trading truly detect private information?
  • What is the impact of insider trading on the market participation of other agents?
  • What is the anatomy of insider trading? How do insiders disguise their trades?
  • How is the criminal activity prosecuted and punished and how does it affect the economic future of implicated entities? More broadly, is there a role for successful policy-making to make financial markets informationally more efficient?

A second project will examine the broad socio-economic implications for growing income inequality. While evidence in the data seems to suggest rising inequality across nations and over time, the possible mechanisms to explain it are still in their infancy so the researchers will build and test a state-of-the-art information-based general equilibrium model having some agents.

This project will have a wide-reaching impact and contribute to various strands of literature, including that on informed trading, market efficiency, the origin of asset prices, skill-based investing, and heterogeneous agents. The micro-founded concept of information will then be applied to other socio-economic contexts to understand problems such as the origin of criminal behaviour among white-collar workers, the importance of legal prosecution of financial crime, the growing disparity in incomes and potential social implications thereof for prosperity and economic growth.