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RFS Advance Access originally published online on October 15, 2003
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Rev Fin 2004; 17:295-337
The Review of Financial Studies Vol. 17, No. 2, pp. 295–337 © 2004 The Society for Financial Studies; all rights reserved.

Strategic Trading, Liquidity, and Information Acquisition

Haim Mendelson
Stanford University

Tunay I. Tunca
Stanford University

Address correspondence to Haim Mendelson, Graduate School of Business, Stanford University, Stanford, CA 94305-5105, or e-mail: haim{at}stanford.edu.

We study endogenous liquidity trading in a market with long-lived asymmetric information. We distinguish between public information, tractable information that can be acquired, and intractable information that cannot be acquired. Besides information asymmetry and noise, the adverse-selection spread depends on the diffusion of intractable information and on the interest rate. With endogenous liquidity trading, efficiency is lower than that implied by noise-trading models. Liquidity traders benefit from the information released through the insider's trades in spite of their monetary losses. We study factors that affect the insider's information acquisition decision, including the amount of intractable information, observability, and information acquisition costs.


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