Price reaction and disagreement over public signal

We develop a theory of endogenous disagreement over the interpretation of public news based on the optimal expectation model proposed by Brunnermeier and Parker (2005). In our model, each agent can form an optimal interpretation and agree to disagree with others. We find that endogenous disagreement and trade may arise following public news events. The model predicts that the market price overreacts to uninformative news and underreacts to informative news, thus providing a unified account for the drift in price following significant news events, and the excessive price volatility in response to noisy information.