Trading Cost and Informational Efficiency

Abstract

​We study the effect of trading costs on information aggregation and acquisition in financial markets. For a given precision of investors' private information, an irrelevance result emerges when investors are ex-ante identical: price informativeness is independent of the level of trading costs. This result holds for quadratic, linear, and fixed trading costs in competitive and strategic environments. When investors are ex-ante heterogeneous, trading costs reduce (increase) price informativeness if and only if investors who disproportionately trade on information are more (less) elastic than investors who mostly trade on hedging. Through a reduction in information acquisition, trading costs reduce price informativeness.