NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Trading, Communication and the Response of Price to New Information

Gary Gorton, James Dow

NBER Working Paper No. 3687*
Issued in April 1991
NBER Program(s):   ME

The dynamic behavior of security prices is studied in a setting where two agents trade strategically and learn over time from market prices. The model introduces an information structure which is intended to capture the notion that information is difficult to interpret. Strategic interaction and the complexity of the information result in a protracted price response. Indeed, equilibrium price paths of the model may display reversals in which the two traders rationally revise their beliefs, first in one direction, and then in the opposite direction, even though no new information has entered the system. A piece of information which is initially thought to be bad news may be revealed, through trading, to be good news.

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