We study a noisy rational expectations equilibrium in a multi-asset economy populated by informed and uninformed investors and noise traders. The assets can include state contingent claims such as Arrow–Debreu securities, assets with only positive payoffs, options or other derivative securities. The probabilities of states depend on an aggregate shock, which is observed only by the informed investor. We derive a three-factor CAPM with asymmetric information, establish conditions under which asset prices reveal information about the shock, and show that information asymmetry amplifies the effects of payoff skewness on asset returns. We also find that volatility derivatives make incomplete markets effectively complete, and their prices quantify market illiquidity and shadow value of information to uninformed investors.

The growth of the asset management industry has made it commonplace for firms to have multiple institutional blockholders. In such firms, the strength of governance via exit depends on how blockholders react to each other’s exit. We present a model to show that open-ended institutional investors such as mutual funds react strongly to an informed blockholder’s exit, leading to correlated exits that enhance corporate governance. Our analysis points to a new role for mutual funds in corporate governance. We examine the trades of mutual funds around exits by activist hedge funds to present empirical evidence consistent with our model.