Informed trading, investment, and welfare

This article studies the welfare economics of informed stock market trading. We analyze the effect of more informative prices on investment, given that this dependence will itself be reflected in equilibrium prices. While a higher incidence of informed speculation always increases firm value through a more informative trading process, the effect on agents’ welfare depends on how revelation of information changes risk‐sharing opportunities in the market. Greater revelation of information that agents wish to insure against reduces their hedging opportunities. On the other hand, early revelation of information that is uncorrelated with hedging needs allows agents to construct better hedges.