Trade-Off? What Trade-Off: Information Production without Illiquidity

Abstract

Private information in financial markets enhances the informational content of asset prices and thereby supports efficient resource allocation. Yet, informed traders extract rents at the expense of uninformed traders, generating a trade-off between price informativeness and liquidity costs. Moreover, equilibrium investment in information acquisition may be socially excessive or insufficient. We show, using a mechanism design approach, that a market structure separating the market for information from the market for liquidity can simultaneously deliver price informativeness, preserve liquidity, and align private incentives with efficient levels of information production.