Journal Article

Learning by Holding and Liquidity

Guillaume Plantin

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 76, issue 1, pages 395-412
Published in print January 2009 | ISSN: 0034-6527
Published online January 2009 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2008.00526.x
Learning by Holding and Liquidity

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  • Information, Knowledge, and Uncertainy
  • Financial Institutions and Services
  • Economics

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A number of assets do not trade publicly but are sold to a restricted group of investors who subsequently receive private information from the issuers. Thus, the holders of such privately placed assets learn more quickly about their assets than other agents. This paper studies the pricing implications of this “learning by holding”. In an economy in which investors are price takers and risk-neutral, and absent any insider trading or other transaction costs, we show that risky assets command an excess expected return over safe assets in the presence of learning by holding. This is reminiscent of the “credit spread puzzle”—the large spread between BBB-rated and AAA-rated corporate bonds that is not explained by historical defaults, risk aversion, or trading frictions. The intuition is that the seller of a risky bond needs to offer a “coordination premium” that helps potential buyers overcome their fear of future illiquidity. Absent this premium, this fear could become self-justified in the presence of learning by holding because a future lemons problem deters current market participation, and this in turn vindicates the fear of a future lemons problem.

Keywords: D82; D83; G11; G23

Journal Article.  8116 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy ; Financial Institutions and Services ; Economics

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