Price Volatility and Investor Behavior in an Overlapping Generations Model with Information Asymmetry

  • Author(s): MASAHIRO WATANABE
  • Published: Jan 10, 2008
  • Pages: 229-272
  • DOI: 10.1111/j.1540-6261.2008.01315.x

ABSTRACT

This paper studies an overlapping generations model with multiple securities and heterogeneously informed agents. The model produces multiple equilibria, including highly volatile equilibria that can exhibit strong or weak correlations between asset returns—even when asset supplies and future dividends are uncorrelated across assets. Less informed agents rationally behave like trend‐followers, while better informed agents follow contrarian strategies. Trading volume has a hump‐shaped relation with information precision and is positively correlated with absolute price changes. Finally, accurate information increases the volatility and correlation of stock returns in the highly volatile, strongly correlated equilibrium.

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