Essays on financial markets with asymmetric information

Chapter 1 analyzes a model of multiple overconfident traders submitting market orders where traders’ private information is subject to correlated errors. We consider two standard types of overconfidence: overestimation of the trader’s own information (κ-overconfidence) and underestimation of other traders’ information (η-overconfidence). The analyses on the effects of overconfidence suggest that trading volume increases with κ-overconfidence and decreases with η-overconfidence. In addition, whereas κ-overconfidence causes trading volume to rise at a steeper pace with the number of traders so that large trading volume can occur with a small extent of κ-overconfidence, η-overconfidence may cause trading volume and price informativeness to decrease with the number of traders. Chapter 2 presents an extension of the model considered in Chapter 1 to endogenous information. The analyses show that κ-overconfidence and the endogeneity of information lead to two qualitatively distinct equilibria in information acquisition. One of which features information aggregation with a sufficient number of traders, whereas the other one does not. Chapter 3 analyzes a model of financial markets featuring heterogeneities in asset valuations and private information where a fraction of informed investors trading on the asset value incur transaction costs, as well as its variant with market power. We consider how reducing such costs affects the welfare of uninformed investors, which changes through their trading opportunities and learning from the price. In the basic model with price-taking investors, reducing the transaction costs makes uninformed investors better off if and only if these uninformed investors have a sufficiently large liquidity shock. Given any positive size of liquidity shock of uninformed investors, this is the case with sufficiently i large trading volume of the cost-bearing investors. In the variant with a large investor who is subject to his own liquidity shock, reducing the transaction costs may increase the welfare of uninformed investors even without their liquidity shock due to improved market liquidity.