Abstract not found

Abstract In a financial market where traders are risk averse and short lived, and prices are noisy, asset prices today depend on the average expectation today of tomorrow's price. Thus (iterating this relationship) the date 1 price equals the date 1 average expectation of the date 2 average expectation of the date 3 price. This will not in general equal the date 1 average expectation of the date 3 price. We show how this failure of the law of iterated expectations for average belief can help understand the role of higher order beliefs in a fully rational asset pricing model and explain over-reaction to (noisy) public information. * This is a much revised version of the paper with the longer title "Beauty Contests, Bubbles and Iterated Expectations in Asset Markets". We thank seminar participants at the LSE, the Bank of England, the IMF, Stanford, the accounting theory mini-conference at Chicago GSB, and the Gerzensee finance meetings for their comments. We thank Mehul Kamdar for capable research assistance. We are grateful to the editor, Maureen O'Hara and a referee for their guidance.

Spatt, and members of the Finance workshops at Northwestern and

to an anomyous referee, whose suggestions have greatly improved the paper. The authors gratefully acknowledge the contribution of Thomson Financial for providing earnings per share forecast data, available through the

In a financial market where traders are risk averse and short lived, and prices are noisy, asset prices today depend on the average expectation today of tomorrow’s price. Thus (iterating this relationship) the date 1 price equals the date 1 average expectation of the date 2 average expectation of the date 3 price. This will not in general equal the date 1 average expectation of the date 3 price. We show how this failure of the law of iterated expectations for average belief can help understand the role of higher order beliefs in a fully rational asset pricing model and explain overreaction to (noisy) public information.

This study examines how heterogeneity of private information may induce finan-cial contagion. Using a model of multi-asset trading in which the three main channels of contagion through financial linkages in the literature (correlated information, correlated liquidity, and portfolio rebalancing) are ruled out by construction, I show that financial contagion can still be an equilibrium outcome when speculators receive heterogeneous fundamental information. Risk-neutral speculators trade strategically across many assets to mask their information advantage about one asset. Asymmetric sharing of information among them prevents rational market makers from learning about their indivi-dual signals and trades with sufficient accuracy. Incorrect cross-inference about terminal payoffs and contagion ensue. When used to analyze the transmission of shocks across countries, my model suggests that the process of generation and disclosure of information in emerging markets may explain their vulnerability to financial contagion (JEL D82, G14, G15). Many recent financial crises were initiated by episodes of ‘‘local’ ’ turmoil

time and comments. Special thanks are due to Simon Gervais. I also wish to acknowledge the comments

This paper develops a model of information collection about publicly traded firms in an economy. The supply noise is modeled as the variability of liquidity-motivated trading in the shares of the firm. The paper theoretically examines the influence of various firm characteristics on the amount of information collected about a firm and on the marginal information content of announcements made by it. Empirical work focuses on the marginal information content of quarterly earnings announcements made by firms. The empirical results are generally consistent with the model's predictions.

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This paper examines the relation between information differences across investors (i.e., information asymmetry) and the cost of capital, and establishes that with perfect competition information asymmetry makes no difference. Instead, a firm's cost of capital is governed solely by the average precision of investors ' information. With imperfect competition, however, information asymmetry affects the cost of capital even after controlling for investors ’ average precision. In other words, the capital market’s degree of competition plays a critical role for the relation between information asymmetry and the cost of capital. This point is important to empirical research in finance and accounting.