On the marginal impact of information and arbitrage

Adi Schnytzer, Yuval Shilony, Richard Thorne

Research output: Chapter in Book/Report/Conference proceedingChapterpeer-review

4 Scopus citations


Introduction It is self-evident that information is valuable, even indispensable, for optimal decision making when investing in financial markets. A question which naturally arises is: at what point, if any, does the cost of additional information gathering exceed the bene?ts? The question is complicated by the fact that information is not a homogeneous commodity. This distinguishes our question from that posed by Stigler (1961) on the diminishing marginal returns to (homogeneous) searching for the lowest price of a commodity. Under certain conditions, Radner and Stiglitz (1984) showed that for an expected utility maximisation problem under constraint, themarginal value of information at the point of no information is non-positive. For a similar result in a principal-agent setting see Singh (1985). These results suggest that information has a risingmarginal value when information is first accumulated. Indeed, it is easy to ?nd examples of particular scenarios where the marginal value of information1 is negative, see below, or not diminishing. The problem arises from the heterogeneity of information in financial markets and is complicated by the existence of both public and private information. On the other hand, it may be that, if the investors gather information about a large number of stocks, the proposition of positive but diminishing returns to information at the successive going market equilibrium points, which develop and change over time, holds true on average. The purpose of this chapter is to present a formal representation of the information accumulation process and to use this representation to formulate the testable hypotheses that, in a financial market, the marginal value of information is, on average, positive and diminishing. Using data from a horse-betting market, it will be shown that this hypothesis cannot be rejected, in spite of the fact that it does not hold for particular horses or races. We show that the fiow of inside information to the market, when its gainful exploitation is permitted, positively impacts upon the market by eradicating remainingbiases in prices and that this impact is diminishing.

Original languageEnglish
Title of host publicationThe Economics of Gambling
PublisherTaylor and Francis
Number of pages15
ISBN (Electronic)0203986938, 9781134508389
ISBN (Print)0415260914, 9780415260916
StatePublished - 1 Jan 2005

Bibliographical note

Publisher Copyright:
© 2003 Leighton Vaughan Williams for selection and editorial matter.


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