A Theory of Rational Investment Screens

We develop a model to explain the value and consequences of investment screens, which are commonly employed by sophisticated investors. In the model, some stock-market investors are uncertain about the quality of private information before they acquire it and, in equilibrium, rationally use prior prices and public information as a screen to predict the returns from information acquisition. We find that larger price surprises lead to more information acquisition, which implies higher future price volatility and trading volumes. We also highlight the determinants of the equilibrium value of investment screens, such as informed trade, noise trade, and public information.