Optimal information acquisition for eliminating estimation risk

Abstract

This paper diverges from previous literature by considering the utility maximization problem in the context of investors having the freedom to actively acquire additional information to mitigate estimation risk. We derive closed-form value functions using CARA and CRRA utility functions and establish a criterion for valuing extra information through certainty equivalence, while also formulating its associated acquisition cost. By strategically employing variational methods, we explore the optimal acquisition of information, taking into account the trade-off between its value and cost. Our findings indicate that acquiring earlier information holds greater worth in eliminating estimation risk and achieving higher utility. Furthermore, we observe that investors with lower risk aversion are more inclined to pursue information acquisition.