Trading Costs and Informational Efficiency
We study the effect of trading costs on information aggregation and acquisition in financial markets. For a given precision of investors' private information, an irrelevance result emerges when investors are ex-ante identical: price informativeness is independent of the level of trading costs. When investors are ex-ante heterogeneous, anything goes, and a change in trading costs can increase or decrease price informativeness, depending on the source of heterogeneity. Our results are valid under quadratic, linear, and fixed costs. Through a reduction in information acquisition, trading costs reduce price informativeness. We discuss how our results inform the policy debate on financial transaction taxes/Tobin taxes.
We would like to thank comments from Fernando Álvarez, Snehal Banerjee, Gadi Barlevy, Bruno Biais, Philip Bond, Markus Brunnermeier, Eric Budish, James Dow, Emmanuel Farhi, Simon Gervais, Piero Gottardi, Joel Hasbrouck, Arvind Krishnamurthy, Stephen Morris, Thomas Philippon, Adriano Rampini, Tom Sargent, Alp Simsek, Laura Veldkamp, Venky Venkateswaran, Xavier Vives, Brian Weller, Wei Xiong, and Jeff Zwiebel, as well as our discussants Kerry Back, Bradyn Breon-Drish, Liyan Yang, and Haoxiang Zhu. We would also like to thank seminar participants at NYU, 2016 London FTG Summer Conference, SED, MIT, UCSB LAEF Conference, 2017 AFA, Duke, ASU-Sonoran Winter Conference, Princeton, Stanford, Macro-Finance Society, and FIRS. Yangjue Han, Luke Min, Josh Mohanty, and Ryungha Oh provided excellent research assistance. Financial support from the CGEB at NYU Stern is gratefully acknowledged. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.