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Information Markets and the Comovement of Asset Prices

Authors: Veldkamp, Laura L.
Keywords: Comovement;herding;information market;asset pricing
Issue Date: 17-May-2004
Series/Report no.: S-MF-04-12
Abstract: Traditional asset pricing models predict that covariance between prices of different assets should be lower than what we observe in the data. This model generates this high covariance within a rational expectations framework by introducing markets for information about asset payoffs. When information is costly, rational investors will not buy information about all assets; they will learn about a subset. Because information production has high fixed costs, competitive producers charge more for low-demand information than for high-demand information. A price that declines in quantity makes investors want to purchase a common subset of information. If investors price many assets using a common subset of information, then a shock to one signal is passed on as a common shock to many asset prices. These common shocks to asset prices generate `excess covariance.' The cross-sectional and time-series properties of asset price covariance are consistent with this explanation.
Appears in Collections:Macro Finance

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