Demand for Information on Assets with Gaussian Returns∗

In order to explore the incentives for information acquisition in financial markets, a model of the joint information and portfolio choice is developed. Investors are allowed to acquire a number of signals that inform about a risky asset’s dividend, and “informational efficiency” is defined as a social planner’s preferred signal allocation. If dividends are Gaussian, utility is CARA, and prices are fully revealing, a complete rational expectations equilibrium does exist—contrary to a wide-held conjecture. The equilibrium entails no information acquisition and is informationally efficient. The reason is that the transmission of information through price to other investors brings market expectations closer to each investor’s own expectations. This reduces the difference between expected payoffs and the asset price, a negative effect of more information, which outweighs the benefit of more precise information for Gaussian dividends. When prices are only partly informative, some investors start acquiring information as long as markets are sufficiently small so that prices reveal little information to others. However, the acquisition of more information inflicts a negative externality on uninformed investors who rationally extract information from price. Thus, markets are likely to be informationally inefficient as informed investors tend to acquire too much information. JEL: G14, D81 ∗I have benefited from insightful discussions with Maury Obstfeld and David Romer, and early explorations with Andy Rose. I am grateful to Achim Wambach, Bob Anderson, Chris Shannon, Sven Rady, and seminar participants at Ibmec Rio de Janeiro, University of California, Berkeley and University of Munich for many helpful comments. A previous version of this paper circulated as “A contribution to the theory of information acquisition in financial markets.” †[email protected] (www.econ.ucsd.edu/muendler)