When it comes to financial markets, how much is too much information?
Finance researcher is interested in whether the regulations surrounding financial information and disclosures make sense
In finance, even a little information can have a huge impact. Intel on an organization’s operations, a glimpse at a firm’s annual budget, or seeing a company mentioned in the news can drastically drive stock prices up or down.
Understanding exactly how financial information is produced and transmitted, as well as how this data effects the economy has long intrigued Liyan Yang, a professor in the Finance area at the Rotman School of Management.
These issues impact all of us, explains Yang, who has won several prestigious research awards, including the 2016 Bank of Canada’s Governor General Award. Whether you work in finance, hold investments or simply contribute to a pension fund, everyone is tied to the market in some way.
Generally, Yang’s research examines how financial participants, such as hedge fund and mutual fund managers collect and trade information. He is also interested in whether regulations surrounding financial information, including transparency requirements, are appropriate and the impact on financial participants’ welfare.
On one hand, access to fundamental financial information, including the Bank of Canada’s data on employment and interest rates, is critical for general transparency and policy decisions. However, disclosing too much information might have unintended and negative consequences on the market.
“Intuitively, most of us are under the impression that more transparency means a more equitable or fairer market,” says Yang. “In reality, the market is quite complex and dynamic. If we demand more access to information, we might observe behaviours we didn’t expect.”
For example, financial analysts and hedge fund managers who are forced to publically disclose their trade secrets and strategies would be left with little incentive for developing new trading algorithms or making trades, he explains.
Regarding regulation issues, Yang recently looked at the implications of allowing stock exchanges to sell market data. This research, which was honoured with the William F. Sharpe Award for Scholarship in Financial Research, was completed during a particularly relevant time when the Securities and Exchange Commission and the Committee of European Securities Regulators were evaluating their market information disclosure policies.
In this paper, Yang and his colleagues show that selling price data increases volatility and increases the cost of capital (which typically indicates that investments are higher risk). As well, this practice also worsens market efficiency and liquidity — in other words, stock prices would not accurately reflect relevant, available information and assets could not be quickly bought or sold — and discourages the production of fundamental information, compared to a scenario where all traders have access to the same information about prices.
Generally, allowing exchanges to sell price information benefits exchanges and harms independent investors and traders. Instead, the authors urge for price data to be available freely.
So, is there an optimal amount of information for financial participants to disclose? The short answer is yes — but it’s a difficult question to tackle, says Yang.
“Striking that balance between an opaque and transparent market is challenging,” he explains. “Determining how much information is too much information to disclose depends on a lot of factors and there will always be trade-offs.”
“The different players in the market — traders, companies and regulators — and how they react to information may affect that balance of how much information to disclose and how much to hold onto,” he adds.
These reactions — as well as whether information might crowd out, or discourage, more information from being produced and disclosed — add to the complexity.
“Many questions remain to be addressed, and more research on understanding information disclosure in financial markets is crucial,” Yang adds.