The Information Asymmetry Hypothesis is a form of counter-argument to the Efficient Market Hypothesis. In economics, information asymmetry occurs in a transaction when one party is privy to more information than the other. The information may be collected voluntarily or involuntarily, but markets do not adjust to equilibrium until the information is disposed to both sides of the parties involved in the transaction. In an asymmetric market, one could achieve returns in excess of the market average if they possess knowledge of information that has not been accepted by the public.
This information could be possessed in common knowledge with insiders. The ex-post structure of private label securities sold by Wall Street investment banks is an example of an asymmetric market. The collapse of Bear Stearns is an example of a bank that profiteered and failed because of information asymmetries during the boom and bust that transpired from the Financial Crisis of 2007-2008.
When a bank such as BS (pun intended) sells a PLS rated AAA to investors, they are able to produce a profit from the asymmetric market.
In a crowd mentality, it may be difficult at first to convince the insider that security is not truly what it appears to be on the surface. Only when the cash flows fail to materialize for a large cohort of investors with access to capital, does the information become transparent, at which point the market may or may not adjust efficiently. A sufficient time lag may exist between the point that cash flows and information passes through to the investors. The time lag is correlated with the remittance cycle of the security and the share of their portfolio that the security represents. An investor with large capital position in a PLS security may/may not liquidate immediately. They could choose to act on their new information and buy a put option or credit-default swap as insurance. The investor cohort creates a liquidity run and the market adjust to the information as it dissipates through the economic system.
The Efficient Market Hypothesis assumes that all information publicly available is transparent. The information can be publicly available and opaque until the investor cohort acts on the information with real capital. This creates even greater information asymmetries because of the large position and access to liquidity of the investor cohort in the failed security. The investor cohort has first mover advantage resulting in a cascading effect as the information transforms from translucent to transparent through market pricing.
The investor cohort experienced information asymmetry when they purchased and liquidated the PLS. The herd mentality piggy-backs off the liquidation creating a liquidity run as the bottom falls out of the infected markets.
http://en.wikipedia.org/wiki/Information_asymmetry
http://en.wikipedia.org/wiki/Efficient-market_hypothesis
This information could be possessed in common knowledge with insiders. The ex-post structure of private label securities sold by Wall Street investment banks is an example of an asymmetric market. The collapse of Bear Stearns is an example of a bank that profiteered and failed because of information asymmetries during the boom and bust that transpired from the Financial Crisis of 2007-2008.
When a bank such as BS (pun intended) sells a PLS rated AAA to investors, they are able to produce a profit from the asymmetric market.
In a crowd mentality, it may be difficult at first to convince the insider that security is not truly what it appears to be on the surface. Only when the cash flows fail to materialize for a large cohort of investors with access to capital, does the information become transparent, at which point the market may or may not adjust efficiently. A sufficient time lag may exist between the point that cash flows and information passes through to the investors. The time lag is correlated with the remittance cycle of the security and the share of their portfolio that the security represents. An investor with large capital position in a PLS security may/may not liquidate immediately. They could choose to act on their new information and buy a put option or credit-default swap as insurance. The investor cohort creates a liquidity run and the market adjust to the information as it dissipates through the economic system.
The Efficient Market Hypothesis assumes that all information publicly available is transparent. The information can be publicly available and opaque until the investor cohort acts on the information with real capital. This creates even greater information asymmetries because of the large position and access to liquidity of the investor cohort in the failed security. The investor cohort has first mover advantage resulting in a cascading effect as the information transforms from translucent to transparent through market pricing.
The investor cohort experienced information asymmetry when they purchased and liquidated the PLS. The herd mentality piggy-backs off the liquidation creating a liquidity run as the bottom falls out of the infected markets.
http://en.wikipedia.org/wiki/Information_asymmetry
http://en.wikipedia.org/wiki/Efficient-market_hypothesis
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