Word of Mouth and Gradual Information Diffusion in Asset Markets
نویسنده
چکیده
We develop a model of gradual information diffusion based on word of mouth communication. When news is initially released to a small fraction of investors, the expected diffusion rate (the change in the fraction of investors with the news) is initially increasing in time and only then decreases. Assuming risk-averse investors trade when they receive the news, the serial correlation of stock returns is proportional to the diffusion rate. We confirm the predicted non-linearity of the diffusion rate. Focusing on very large stocks where liquidity is less of an issue, we decompose returns into a component based on earnings releases (public news) and a residual (private news). The serial correlation of a return due to public news with future returns declines in time. In contrast, the serial correlation of a return due to private news with future returns initially increases and only then decreases in time.
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