Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding

Abstract

Asset prices are driven by public news and information that is dispersed among many market participants. Traditional asset pricing theories have assumed that all investors hold symmetric information. Research in the past two decades has shown that the inclusion of asymmetric information drastically alters traditional results. This book provides a detailed up‐to‐date survey that serves as a map for students and other researchers navigating through this literature. The book starts by introducing the reader to different knowledge, equilibrium, and efficiency concepts. After explaining no‐trade theorems, it highlights the important role of asymmetric information in explaining the existence and anatomy of bubbles. The subsequent overview of market microstructure models shows how information is reflected in prices and how traders can infer it from prices. Insights derived from herding models are used to provide explanations for stock market crashes. If investors have short horizons, price correcting arbitrage activity is limited and investors have a tendency to focus on the same (possible unimportant) news, a phenomena that led Keynes to compare the stock market with a beauty contest. The book concludes with a brief summary of bank runs and their connection to financial crises. In summary, models with asymmetric information provide a better understanding of bubbles, crashes, and other market inefficiencies and frictions.