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Rumors

Authors

  • Jos Van Bommel

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    • Saïd Business School, University of Oxford. This paper came forth from my Ph.D. dissertation at INSEAD. I have greatly benefited from the support and guidance of my dissertation committee consisting of Theo Vermaelen (chair), Paolo Fulghieri, and Matti Suominen. I am also grateful to Michael Goldstein, Lars Tyge Nielsen, Duane Seppi, Erik Sirri, and seminar participants at the NTU international finance conference, the Eastern Finance Association meetings, the American Finance Association meetings, the FMA European meetings, the Norwegian School of Management, Oxford University, Pompeu Fabra University, Tilburg University, and the University of Amsterdam for helpful comments. Last but not least, I thank the editor and an anonymous referee for their constructive feedback on earlier versions. All errors are my own.

ABSTRACT

A Kyle (1985) model with private information diffusion is used to examine the motivation to spread stock tips. An informed investor with limited investment capacity spreads imprecise rumors to an audience of followers. Followers trade on the advice and move the price. Due to the imprecision of the rumor, the price overshoots with positive probability. This gives the rumormonger the opportunity to trade twice: First when she receives information, then when she knows the price to be overshooting. In equilibrium, rumors are informative and both rumormongers and followers increase their profits at the expense of uninformed liquidity traders.

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