Informational Asymmetries and a Multiplier Effect on Price Correlation and Trading

In this paper we show how rational expectations equilibrium models with asymmetric information, without market frictions, can generate extreme co-movements in asset prices. Information asymmetries generate a multiplier effect on price correlation - a World Bank definition of financial contagion. This is shown in two frameworks: perfect and imperfect competition. In the first framework, we also model a version of home-bias, showing why information sharing explains cross-country capital flows. In the second framework, we provide closed form solutions for a model with multiple insiders and assets that generalize the ideas