Information and Learning in Heterogeneous Markets

Abstract

This paper studies the implications of leakage of information through prices for the efficient operation of markets with heterogeneous agents. Focusing on uniform-price double auctions, we first characterize how the presence of heterogeneity (e.g., in terms of agents' trading costs, information precision, or risk attitudes) can shape the information content of prices and hence the market's informational efficiency. We find that price informativeness decreases with the extent of heterogeneity in the market. We then establish that such reductions in price informativeness can in turn manifest themselves as an informational externality: in the presence of heterogeneity, agents do not internalize the impact of their trading decisions on the information revealed to others via prices. We also show that the welfare implications of this heterogeneity-induced informational externality depends on the intricate details of the market. Our results thus indicate that accounting for the possibility of information leakage should be an important consideration in designing markets with asymmetric information. We conclude the paper by exploring the welfare implications of market segmentation in the presence of heterogeneous agents and information leakage.