The pricing effects of ambiguous private information

Ambiguous private information leads to informational inefficiency of market prices in rational expectations equilibrium. This inefficiency implies lower asset prices as uninformed traders require a premium to hold assets. This premium is increasing in the riskiness of the asset and leads to excess volatility, price swings, and abrupt volatility and illiquidity variation across informational efficiency regimes. Public information affects the informational efficiency of price and can also lead to abrupt changes in volatility and illiquidity. ∗We are grateful to Subir Bose, Max Bruche, Giovanni Cespa, David Easley, Pierre-Olivier Gourinchas, Philipp Illedistch, Guy Laroque, Frank Riedel, Peter Sorensen and particularly Liyan Yang for their constructive comments. We thank audiences in Cass (Microstructure Conference 2012), Heidelberg, MPI Bonn, Maastricht, Oslo (EEA-ESEM 2011), Sciences Po, Southampton, UCL, Yale (Cowles GE Conference 2011), Vienna (Ellsberg Workshop 2010), and WBS (Frontiers of Finance 2011) for helpful discussion. This research was supported by a grant from the Institute for New Economic Thinking. We are solely responsible for any errors. †Department of Economics, Brigham Young University, Provo, UT 84602, USA. Telephone: +1 801 422 5306, Fax: +1 801 422 0194, Email: [email protected] ‡Department of Economics, University of Essex, Colchester, Essex CO4 3SQ, UK. Telephone: +44 (0) 1206 872723, Fax: +44 (0) 1206 872724, Email: [email protected]