We test models of asset pricing under asymmetric information using plausibly exogenous variation in the supply of information caused by the closure or restructuring of brokerage firms’
research operations. Consistent with predictions derived from a Grossman and Stiglitz-type model, share prices and uninformed investors’ demands fall as information asymmetry increases. Cross-sectional tests support the comparative statics. Prices and uninformed demand experience larger declines, the more investors are uninformed, the larger and more variable is turnover, the more uncertain is the asset’s payoff, and the noisier is the better-informed investors’ signal. We show that prices fall because expected returns become more sensitive to a liquidity-risk factor
