Informational Black Holes in Financial Markets

Publication Date
Financial Markets Group Discussion Papers DP 754
Publication Authors

We study how efficient primary financial markets are in allocating capital when information about investment opportunities is dispersed across market participants. Paradoxically, the very fact that information is valuable for making real investment decisions destroys the efficiency of the market. To add to the paradox, as the number of market participants with useful information increases a growing share of them fall into an “informational black hole,” making markets even less efficient. Contrary to the predictions of standard theory, social surplus and the revenues of an entrepreneur seeking financing can be decreasing in the size of the financial market, the linkage principle of Milgrom and Weber (1982) may not hold, and collusion among investors may enhance efficiency.