Trading Costs and Informational Efficiency

66 Pages Posted: 22 Oct 2016 Last revised: 23 Jan 2017

See all articles by Eduardo Davila

Eduardo Davila

Yale University - Department of Economics; National Bureau of Economic Research (NBER)

Cecilia Parlatore

New York University (NYU) - Leonard N. Stern School of Business; National Bureau of Economic Research (NBER)

Date Written: August 1, 2016

Abstract

We study the effect of trading costs on information aggregation and information acquisition in financial markets. For a given precision of investors’ private information, an irrelevance result emerges when investors are ex-ante identical: price informativeness does not depend on the level of trading costs. This result holds independently of whether trading costs are quadratic or linear, investors behave competitively or strategically, and applies to both static and dynamic economies. When investors are ex-ante heterogeneous, trading costs reduce (increase) price informativeness if and only if investors who disproportionately trade on information are more (less) elastic than investors who mostly trade due to hedging. Trading costs always reduce information acquisition and consequently price informativeness, even when price informativeness remains unchanged for a given amount of information. Our results matter to understand the consequences of cheaper financial trading and the effects of financial transaction taxes.

Keywords: learning, trading costs, information aggregation, information acquisition, financial transaction taxes

JEL Classification: D82, D83, G14

Suggested Citation

Davila, Eduardo and Parlatore, Cecilia, Trading Costs and Informational Efficiency (August 1, 2016). Available at SSRN: https://ssrn.com/abstract=2856607 or http://dx.doi.org/10.2139/ssrn.2856607

Eduardo Davila

Yale University - Department of Economics ( email )

28 Hillhouse Ave
New Haven, CT 06520-8268
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Cecilia Parlatore (Contact Author)

New York University (NYU) - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States

HOME PAGE: http://www.ceciliaparlatore.com

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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