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Stock Market Volatility in a Heterogeneous Information Economy

Published online by Cambridge University Press:  06 April 2009

Bruce D. Grundy  and
Youngsoo Kim
Bruce D. Grundy
Affiliation:
b.grundy@mbs.unimelb.edu.au, Melbourne Business School, University of Melbourne, 200 Leicester St., Carlton, Victoria 3053, Australia
Youngsoo Kim
Affiliation:
youngsoo.kim@uregina.ca, Faculty of Administration, University of Regina, 3737 Wascana Parkway, Regina, SK S4S 0A2, Canada.
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Abstract

The informational role of prices contributes positively to their variability. In a noisy rational expectations equilibrium, traders rationally respond to price changes by revising their estimates of other traders' private signals and hence their own expectations of future dividends. The resultant shifts in traders' demands amplify any supply shock-induced price changes. We develop an infinite horizon noisy rational expectations model and calibrate, simulate, and test it using U.S. stock market data. The price variability in a heterogeneous information economy is shown to be 20% to 46% higher than in an otherwise equivalent economy in which all signals are publicly announced.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 37 , Issue 1 , March 2002 , pp. 1 - 27
Copyright
Copyright © School of Business Administration, University of Washington 2002

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