Information, Trading Technology, and Financial Sector Profits


Common wisdom in financial markets is that there is temporary arbitrage, or at least a skewed split of surplus, that can be exploited by agents using private information. This is reflected in the enormous investment in market data and trading technologies in the financial services sector. However, Milgrom and Stokey (1982) and Grossman and Stiglitz (1980) show that asymmetric information alone cannot be exploited by an agent in a Walrasian equilibrium, and that this prevents private gains to investment in information precision - which, in turn, can make markets informationally inefficient. This research attempts to resolve this paradox by introducing a model with asymmetric information and precision, but where the micro-structure of market clearing introduces private returns to investment in signal precision, and frictions in the speed of information diffusion are reflected in the aggregate price distribution.

Work in Progress