Costly Interpretation of Asset Prices

52 Pages Posted: 16 Oct 2017 Last revised: 2 Oct 2018

See all articles by Xavier Vives

Xavier Vives

University of Navarra - IESE Business School; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Liyan Yang

University of Toronto - Rotman School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: October 2017

Abstract

We propose a model in which investors cannot costlessly process information from asset prices. At the trading stage, investors are boundedly rational and their interpretation of prices injects noise into the price, generating a source of endogenous noise trading. Our setup predicts price momentum and yields excessive return volatility and excessive trading volume. In an overall equilibrium, investors optimally choose sophistication levels by balancing the benefit of beating the market against the cost of acquiring sophistication. There can exist strategic complementarity in sophistication acquisition, leading to multiple equilibria.

Suggested Citation

Vives, Xavier and Yang, Liyan, Costly Interpretation of Asset Prices (October 2017). CEPR Discussion Paper No. DP12360, Available at SSRN: https://ssrn.com/abstract=3053886

Xavier Vives (Contact Author)

University of Navarra - IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain

HOME PAGE: http://wwwapp.iese.edu/faculty/facultyDetail.asp?lang=en&prof=xv

Centre for Economic Policy Research (CEPR)

London
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute for Economic Research) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Liyan Yang

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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