Snehal Banerjee

Learning from Prices and the Dispersion in Beliefs

The article develops a dynamic model that nests the rational expectations (RE) and differences of opinion (DO) approaches to study how investors use prices to update their valuations. When investors condition on prices (RE), investor disagreement is related positively to expected returns, return volatility, and market beta, but negatively to return autocorrelation. When investors do not use prices (DO), these relations are reversed. Tests of these predictions on the cross-section of stocks using analyst forecast dispersion and volume as proxies for disagreement provide empirical evidence that is consistent with investors using prices on average. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Signal or Noise? Uncertainty and Learning about Whether Other Traders are Informed

We develop a model where some investors are uncertain whether others are trading on informative signals or noise. Uncertainty about others leads to a nonlinear price that reacts asymmetrically to news. We incorporate this uncertainty into a dynamic setting where traders gradually learn about others and show that it generates empirically relevant return dynamics: expected returns are stochastic but predictable, and volatility exhibits clustering and the “leverage” effect. The model nests both the rational expectations (RE) and differences of opinions (DO) approaches and highlights a link between disagreement about fundamentals and uncertainty about other traders.In standard rational expectations models, investors know whether others are informed, and therefore know how to update their beliefs using prices. We develop a dynamic model in which investors must learn whether others are informed and, therefore, learn how to use the information in prices. We show that the price is a non-linear function of the underlying signal, and expected returns and volatility are stochastic and persistent, even though shocks to fundamentals and signals are i.i.d. The price reaction to information about dividends is asymmetric: the price reacts more strongly to bad news than it does to good news. The model also generates volatility clustering in which large return realizations, which are associated with dividend surprises, are followed by higher volatility and higher expected returns.

When Transparency Improves, Must Prices Reflect Fundamentals Better?

No. In the presence of speculative opportunities, investors can learn about both asset fundamentals and the beliefs of other traders. We show that this learning exhibits complementarity: learning more along one dimension increases the value of learning about the other. As a result, regulatory changes may be counterproductive. First, increasing transparency (i.e., making fundamental information cheaper to acquire) can make prices less informative when investors respond by learning relatively more about others. Second, public disclosures discourage private learning about fundamentals, while encouraging information acquisition about others. Accordingly, disclosing more fundamental information can decrease overall informational efficiency by decreasing price informativeness. Received April 20, 2016; editorial decision September 30, 2017 by Editor Itay Goldstein.

Dynamic Information Acquisition and Strategic Trading

We develop a continuous-time Kyle (1985) model where the strategic trader dynamically chooses when to acquire costly information about an asset’s payoff, instead of being endowed with this information. We show that whether the market maker observes the acquisition decision plays an important role. When information acquisition is observable, there exists an equilibrium in which the trader’s acquisition decision follows a pure strategy and delay, relative to a naive NPV rule, is optimal. In contrast, when the acquisition decision is not observable, we show that an equilibrium with smooth trading and a pure acquisition strategy cannot exist. We also rule out the existence of a class of equilibria with smooth trading in which the trader mixes between acquiring information and not. These results suggest that the standard Kyle trading equilibrium is difficult to reconcile with costly, dynamic information acquisition, when the acquisition decision is unobservable. JEL: D82, D84, G12, G14

Transparency versus Tone: Public Communication with Limited Commitment

Communication of public information is an integral aspect of policy-making by central banks and governments. We study public communication by a policymaker who cannot fully commit to a disclosure policy. The policymaker chooses not only the transparency of its communication (i.e., the precision of the public signal), but also its tone (i.e., the mean of the signal). Without commitment, the policymaker faces a trade-off between being informative and being manipulative. We show that an informative equilibrium exists if and only if the policymaker’s incentives are perfectly aligned with those of the individuals. When there is a conflict of interest, the optimal communication is always completely uninformative. This is not because the public signal is imprecise, but because the policymaker’s tone is overly optimistic or pessimistic --- in equilibrium, the policymaker babbles precisely. We also show that tone is crucial to the effectiveness of policy interventions in the absence of commitment.

Conceal to Coordinate

How informative is communication when players have an incentive to coordinate, but cannot commit to disclosing their private information? We study one-sided cheap talk in a two player investment game, where each player has noisy private information about fundamentals and the investment decision exhibits complementarity. Despite incentives to coordinate, we find that informative cheap-talk is fragile. Even when payoffs are symmetric, the sender must conceal information: when she chooses to invest, she only reveals that she will invest. We then ask whether the ability to commit to full disclosure is valuable. Surprisingly, we find that both the sender and the receiver may prefer partially informative cheap-talk to an equilibrium in which the sender commits to disclosing her information perfectly.