A Dynamic Asset Pricing Model Under Incomplete Information

In this paper, I develop a model of competitive stock trading where investors are heterogeneous about their information on future stock returns. Different from previous studies, in this model, I assume that there are two fundamentals of the dividends process, which co-determine the expectation of future dividends. By introducing two fundamentals in my model, I show that, with the decreasing of the degree of the information asymmetry on the first fundamental, the general trading volume in the market does not necessarily decrease very much, for the information asymmetry on the second fundamental among investors that can not be removed easily still act as the major trading motive of investors in the market. The main purpose of this paper is to show, as a pure informational trading motive of the investors in the market, the information asymmetry on the second fundamental among investors can help us to get a better understanding towards the investment behavior of large players, like institutional investors, without introducing any kind of non-informational trading motive. In addition, I will examine the link between the nature of heterogeneity among investors and the behavior of trading volume. I will also briefly discuss how informational trading affects the trading behavior of both classes of investors and the dynamics of trading volume and stock prices.