When transparency improves, must prices reflect fundamentals better?
Snehal Banerjee, Jesse Davis and Naveen Gondhi
Northwestern University
March 2015
Abstract
No. Regulation often mandates increased transparency to improve how well prices reflect fundamentals. We show that such policy can be counterproductive. We study the optimal decision of an investor who can choose to acquire costly information not only about asset fundamentals but also about the behavior of liquidity traders. We characterize how changing the cost of information acquisition a ffects the extent to which prices reflect fundamentals. When liquidity trading is price-dependent (e.g., due to forced deleveraging),surprising results emerge: higher transparency, even if exclusively targeting fundamentals,can decrease price informativeness, and cheaper access to non-fundamental information can improve efficiency.
JEL Classi cation: G14, D82, G18
Keywords: Transparency, Price efficiency, Regulation, Information Acquisition
