Asian Review of Financial Research Vol.23 No.2 pp.159-212
Acquisition of Non-Fundamental Information in the Kyle Model of Speculation
Key Words : Information Acquisition,Speculation,Informed Trading,Non-Fundamental Information
This paper explores the impact of multidimensional uncertainty on people's incentives to acquire information using the Kyle model of informed trading. In a single period Kyle model, the informed trader is worse off if he acquires information (called non-fundamental information) about the level of noise trading. This is due to the fact that the informed trader, by betting against noise traders, reduces the variance of the total noise related trading; he gains from such a bet, but loses part of profits from fundamental trading. If there is a speculator who trades only on non-fundamental information, the informed trader is better off acquiring information that is dominated by the speculator's whereas acquiring non-fundamental information that is not dominated could make the informed trader worse off than without such information. Moreover, the informed trader is much better off sharing such dominated information with the speculator after acquiring it. When there are two traders who have fundamental information, the less informed trader has stronger incentives to acquire non-fundamental information. We also show that non-fundamental information provides a better return if the noise trading has a bigger variance than the asset value. The overall picture emerging from this exercise is that traders who focus on fundamentals do not have strong incentives to acquire non-fundamental information.