Trading, Profitability, and Volatility in a Dynamic Information Network Model∗ Preliminary and incomplete

We introduce a dynamic noisy rational expectations model, in which information diffuses through a general network of agents. In equilibrium, agents’ trading behavior and profitability are determined by their position in the network. Agents who are more closely connected have more similar period-by-period trades, and an agent’s profitability is determined by how central the agent is, using a centrality measure that is closely related to so-called Katz centrality. The model generates rich dynamics of aggregate trading volume and volatility, beyond what can be generated by heterogeneous preferences in a symmetric setting. Casual observations suggest that price and volume dynamics of small stocks in the market may be especially well explained by such asymmetric information diffusion. The model could potentially be used to study individual investor behavior and performance, and to analyze endogenous network formation in financial markets. ∗I thank seminar participants at the Duisenberg School of Finance, Maastrict University, Rochester (Simon School) and the Oxford-Man Institute, Nicolae Garleanu, Brett Green, Pierre de la Harpe, Svante Jansson, Ron Kaniel, Anders Karlsson, Martin Lettau, Dmitry Livdan, Hanno Lustig, Gustavo Manso, Christine Parlour, and Han Ozsoylev for valuable comments and suggestions. †Haas School of Business, University of California at Berkeley, 545 Student Services Building #1900, CA 94720-1900. E-mail: [email protected], Phone: +1-510-643-0547. Fax: +1-510-643-1420.