UC Irvine

Learning from market prices by decision-makers in the real side of the economy affects informed investor trading behavior and financial market efficiency, which feedback to managers' decisions and real efficiency. Such a feedback loop provides some interesting results on what could be equilibrium outcomes in the financial markets. In this doctoral dissertation, I study the role managerial learning from financial market prices plays in various financial and economic settings.

Chapter 1 studies the dark pool effects on price discovery and real efficiency when firm managers who need to make production investment decisions learn information from financial market prices. A strategic informed investor trades on private information and chooses a trading venue between an exchange market and a dark pool. An uninformed noise investor randomly selects a trading venue and randomly trade. Managerial learning leads to wiser real decisions and results in higher firm value, which aggravates the buying profits and alleviates the short-selling profits of the informed investor. The magnitude of managerial learning effects and the execution risk of dark pool trading vary in the noise trading in the exchange market. As a result, the dark pool effects on informed investor trading venue choice, exchange market efficiency, and real efficiency all depend on the noise trading in the exchange market.

Chapter 2 investigates the dark pool effects on investor trading venue choice in a model featuring managerial learning from exchange market prices. The model is essentially the one studied in Chapter 1 with transaction cost in the exchange market and delay cost of the uninformed liquidity investor that make the uninformed liquidity investor trading venue choice endogenous. While the transaction cost and the delay cost affect the informed trading and liquidity trading in the exchange market, the dark pool does not divert investors away from the exchange market and thus does not affect the exchange market efficiency. However, the dark pool may initiate investors' coordination motives to trade in the dark pool whenever trading in the exchange market can not bring higher profits than choosing not to trade.

Chapter 3 analyzes the interaction between secondary financial market efficiency and product market competition in an entry game. A potential entrant learns from an insider's trading in the stock market of a monopoly incumbent, such that the insider and the entrant have conflicting interests. Once the entrant enters, it competes with the incumbent in a Cournot duopoly setting and reduces the incumbent firm value. As a result, entrant learning causes ``buy-side'' limits to arbitrage. Depending on different entry barriers, transaction costs in the financial market may increase or decrease entry probability. The impact of transaction costs on the entry probability is also affected by economic and informational conditions that the insider faces. A policy of reducing entry barriers has non-monotonic effects on entry probability.