Optimal research in financial markets with heterogeneous private information: a rational expectations model

This paper investigates prices and endogenous research decision for financial assets. In rational expectations models with public information, higher order beliefs make investors to overweight the public information relative to underlying fundamentals. The extent of this mispricing is higher if the variance of private signals is relatively high. The model presented in this paper extends this setting by incorporating the research cost decision and endogenising the variance of the private signals that short-lived investors obtain in each period. It turns out that investors will be less willing to research in periods when there is an alternative asset with high return available. Furthermore, the optimal research decision will depend on the time left to the maturity of the asset. This explains, in a rational setting, why long lived assets like stocks may be priced based on the public information rather than research on fundamentals. JEL Classification: G12, G14Financial markets imperfections, heterogeneous information, research costs

Financial markets' imperfections and technology adoption

This thesis examines information imperfections in asset markets and its impact on economic performance through technology adoption and innovation. In a rational setting, where equity market participants take into account common public information in addition to their private signals about fundamentals, equity prices are persistently biased towards the public signals. Chapter 2 investigates the real effect of such mis-pricing, when R&D producing firms rely on equity finance. Relating to the recent technology stocks boom, the model shows how market's optimism causes more innovations. Furthermore, such optimism can generate gains in aggregate consumption. Chapter 3 analyzes equity markets' role in facilitating ownership transfer from entrepreneurs investing in adopting technology to managers running these firms once technology is adopted. Information imperfections in equity market affect entrepreneurs' willingness to invest in frontier technology in two ways. First, uncertainty about equity price or lack of market liquidity discourages technology adoption. This can explain slow technology adoption and limited venture capitalists' participation in under-developed equity markets. Second, imperfectly informed market participants take fast adoption as a positive signal. The resulting increase of expected market value encourages technology adoption. Probability of fast technology adoption is highest at an intermediate number of informed investors. Chapter 4 looks more closely into the extent of asset mis-pricing by endogenizing the variance of investors' private signals. Better quality of freely available public information reduces incentives to invest in private information and can magnify the extent of asset mis-pricing. Furthermore, in a dynamic setting, investors' react more slowly on changes of the fundamentals because incentives to invest in research are low in early trading periods. The chapter also shows that availability of longer price history might not bring asset prices closer to the fundamentals, as investors choose to free-ride on other investors' research efforts

Technology Adoption with Exit in Imperfectly Informed Equity Markets

This paper focuses on the importance of equity markets in facilitating the exit of entrepreneurs investing in technology. Entrepreneurs' willingness to invest and aggregate output is affected in two opposite ways. First, uncertainty about equity price or lack of market liquidity discourages technology adoption. This can explain slow technology adoption and limited participation by venture capitalists in underdeveloped equity markets. Second, fast adoption is a positive signal to imperfectly informed equity market participants. This provides a rational explanation for overpricing technology stocks and overinvestment in developed markets. Fast adoption is most probable at an intermediate quality of information. (JEL D82, E23, G12, G31, G32, O33)

Rational quantitative trading in efficient markets

We present a model where quantitative trading − trading strategies based on the quantitative analysis of prices, volumes, and other asset and market characteristics − is systematically profitable for sophisticated traders whose only source of private information is knowing better than other market participants how many fundamental traders, i.e., traders informed about fundamentals, are active in the market. In equilibrium, the direction of optimal quantitative trading depends on the number of fundamental traders and often switches sign when order flow increases: with few fundamental traders, optimal quantitative trading is trend-following (re. contrarian) after small (re. large) price changes; with many fundamental traders, the opposite holds: it is contrarian (re. trend-following) after small (re. large) price changes

Elections with expert politicians

We study elections between two candidates who hold some private information valuable for the whole electorate. Under the standard Downsian assumption of office motivation, we find that there exist fully-revealing equilibria, where the candidates do not conceal any of their information. Surprisingly, however, the fully revealing equilibrium maximizing the electorate welfare has one of the two parties truthfully revealing her signal, and the other one acting as a benevolent dictator: She always selects the platform that maximizes the voter’s welfare, on the basis of her own private information, and she is always voted in power. Hence, self-interested competition among purely opportunities parties turns out to be very poor in aggregating information of expert political candidates. But this is not because politicians pander to the median voter’s beliefs excessively. Indeed, fully-revealing equilibrium strategies turn out to be not sufficiently moderate relative to the socially optimal ones. Turning to the opposite polar extreme of purely benevolent parties, we surprisingly uncover an equilibrium where one party always chooses a platform to the left of the other party, regardless of the candidates’ signal

Can Optimism about Technology Stocks Be Good for Welfare? Positive Spillovers vs. Equity Market Losses

This paper analyzes the impact of equity market information imperfections on R&D driven growth. The mechanism proposed is built on two premises. First, the R&D-sector relies largely on equity finance, because of its production features. Second, equity can be persistently mispriced. This is due to investors rationally taking into account both private and public information. This paper shows that optimism in equity market can generate long-run consumption gains, despite the excess capital losses realized in the short-run. This result arises from the externalities in R&D production that result in uderinvestment in R&D in a market economy with perfect information.Equity mispricing, R&D growth, Optimism, Welfare.

Explaining the performance of firms and countries: What does the business environment play?

It is commonly accepted that the business environment — encompassing features of the legal, regulatory, financial, and institutional system of a country — has an impact on the performance of firms. As barriers to doing business appear to vary widely across regions and countries, it has also been asserted that the business environment will affect aggregate performance. The common underlying assumption is that countries and firms facing ‘better’ business environments can be expected to perform better This paper attempts to evaluate the robustness of these conclusions using two types of data. The first comprises a large firm level dataset — the 2002 and 2005 rounds of the Business Environment and Enterprise Performance Survey (henceforth BEEPS) — that includes measures of firm performance, variables relating to ownership, competition and export orientation as well as perceptions of the business environment. The dataset covers between 6–9,000 firms in 26 transition countries. The second — country level — dataset comprises the World Bank’s annual ‘Doing Business’ survey that covers 175 countries. While this survey has relatively few observations over time — data collection only started in 2003 — it has large country coverage and has already been widely used in cross-country analysis. In this paper, the Doing Business measures are primarily used to try and establish whether there is any link from country-level measures of the business environment to country-level performance. Simon Commander — Associate Professor, Department of Public Administration, School of Management, St. Petersburg State University Jan Svejnar — Professor, University of Michigan Katrin Tinn — Assistant Professor, Stockholm School of Economicsbusiness environment,