# Uncertainty, Information Acquisition and Price Swings in Asset Markets

Abstract: This paper analyzes costly information acquisition in asset markets with Knightian uncertainty about the asset fundamentals. In these markets, acquiring information not only reduces the expected variability of the fundamentals for a given distribution (i.e., risk). It also mitigates the uncertainty about the true distribution of the fundamentals. Agents who lack knowledge of this distribution cannot correctly interpret the information other investors impound into the price. We show that, due to uncertainty aversion, the incentives to reduce uncertainty by acquiring information increase as more investors acquire information. When uncertainty is high enough, information acquisition decisions become strategic complements and lead to multiple equilibria. Swift changes in information demand can drive large price swings even after small changes in Knightian uncertainty.

## Summary (2 min read)

### 1. INTRODUCTION

- A basic tenet of financial economics holds that asset markets help summarize information dispersed across individual investors.
- The second relates to how valuable it is for an ambiguity averse agent to resolve his ambiguity—the “value of parameter uncertainty”.
- The authors show that the value of parameter uncertainty increases precisely as prices become more informative.
- The larger the mass of informed agents, the higher the benefits of becoming informed, also known as Information complementarities result.
- If the drawn ball is not black, then at date-1 the decision maker knows that the drawn ball will be either red or yellow, but does not know which one it will be.

### 4. THE VALUE OF INFORMATION

- This section analyses how ambiguity affects the incentives to acquire fundamental information.
- The value of acquiring information reflects not only a reduction in the payoff risk, but also the agents’ aversion to ambiguity.
- Lack of this knowledge leads an uninformed agent to update his beliefs based on worst-case scenarios: the agent’s expectation Eμ(p) in equation (5.4) is Eμ∗(s) (p), where μ∗(s)=μ when the agent is long the asset and μ∗(s)=.
- By contrast, because the asset supply is Gaussian in the model, lower values of μz increase the probability of the event that the uninformed agents are short the asset.
- The authors show that, in their model, the value of information accounted for by the price can turn negative when the value of parameter uncertainty is high enough.

### 6. EXTENSIONS

- This section considers three extensions, aiming to analyse departures from some of the model assumptions made so far.
- 1. Maximum likelihood updates of prior beliefs With full Bayesian updating, no learning occurs regarding the original set of priors, which means that the uninformed agents retain all their initial priors.
- The model, leads to two main conclusions.
- Smooth ambiguity aversion Maxmin preferences do not allow us to disentangle ambiguity from ambiguity aversion.
- Furthermore, the authors show that information complementarities and multiple equilibria [12:40 9/9/2015 rdv017.tex] RESTUD: The Review of Economic Studies Page: 1553 1533–1567 (Proposition F.1), and a negative value of price information (Proposition F.2), arise only if agents are ambiguity averse, that is, if α>1.

### 7. CONCLUSION

- This article departs from the literature in its focus on the value of information in markets with Knightian uncertainty.
- And regarding the formulation of portfolio choices, see equation (F.4).
- Because asset prices become increasingly informative as more investors acquire information, the value of parameter uncertainty increases with information acquisition.
- Information acquisition decisions become strategic complements: the more investors acquire information, the higher are the incentives to become informed.

Did you find this useful? Give us your feedback

...read more

##### Citations

105 citations

82 citations

### Cites background from "Uncertainty, Information Acquisitio..."

...[FIGURE 1 GOES HERE] The literature (e.g., Barlevy and Veronesi, 2000; Garcia and Strobl, 2011; and Mele and Sangiorgi, 2011) has used learning complementarities and the resulting multiple equilibria to explain large movements in stock prices and excess volatility in financial markets....

[...]

55 citations

54 citations

38 citations

### Cites background from "Uncertainty, Information Acquisitio..."

...The theoretical model of Mele and Sangiorgi (2013) shows that ambiguity aversion can cause investors to exit the stock market when the perceived level of ambiguity increases, which in turn causes large changes in prices.34 Several authors suggest that perceived ambiguity increased sharply during…...

[...]

##### References

22,909 citations

10,053 citations

### "Uncertainty, Information Acquisitio..." refers background in this paper

...We consider a model in which the market fundamentals are subject to ambiguity, or Knightian uncertainty (Keynes, 1921; Knight, 1921)....

[...]

^{1}

6,526 citations

5,541 citations

3,953 citations