| Summary: | How information affects security prices is a central question in finance. I take advantage of regulation unique to Korea Exchange, which requires firms to publicly confirm or deny rumors when inquired. I embed this regulation into a sequential trading model and show that two mechanisms enhance price efficiency. First, the short information advantage period due to firms' pending response to inquiry causes informed traders to trade more aggressively. Second, the number of informed traders---and thus the level of competition---increases after the inquiry. Using data on 204 rumor-disclosure events, I show that this regulation, however, comes at a cost. Although informed traders' response to the regulation enhances price efficiency, the variance of noise trading on average quadruples when the market regulator intervenes. Also, the inquiry occasionally gives false alerts when the rumor is untrue, which allows increase opportunity of informed trading. Informed traders thus earn higher profits than what they would earn in the absence of the regulation. Furthermore, I show that the model can be generalized to incorporate diffusion of information in sequential auction equilibrium model.
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