The Information Diffusion Model
How Information Travels, Prices Adjust, and Market Inefficiencies Emerge
Financial markets are often described as information-processing systems. New information enters the market, investors interpret it, expectations change, capital is reallocated, and prices adjust. In the simplest version of this story, information arrives and prices respond almost immediately.
Reality is considerably more complicated.
Information does not enter a market as a perfectly understood and universally accessible signal; it moves through networks of investors, institutions, analysts, journalists, algorithms, corporate disclosures, trading systems, and social channels. Different participants receive information at different times, interpret it differently, assign different probabilities to its implications, and face different constraints when attempting to act upon it. The resultant effect is that information can diffuse through a market rather than simply arrive in it.
The information diffusion model provides a framework for understanding this process. As rather than treating information as something that instantaneously becomes incorporated into prices, it considers how information spreads through heterogeneous networks and how the speed, direction, and completeness of that diffusion influence market behaviour. This distinction matters because markets are not merely mechanisms for discovering information, they are also mechanisms through which information travels.
Information Is Not the Same as Knowledge
The first distinction is between information and knowledge.
Information can be thought of as an observable signal about the state of the world. A company releases its earnings, a central bank changes its policy guidance, a new regulation is announced, a competitor enters a market, a supply disruption occurs. Yet observing information does not necessarily mean understanding its significance.
An earnings announcement may be immediately available to millions of investors while its long-term implications remain uncertain; a regulatory change may be public knowledge while its consequences for individual companies depend on second-order effects that require substantial analysis; and a macroeconomic release may be incorporated into headline prices rapidly while its implications for different industries take considerably longer to emerge.
Information therefore has at least two dimensions: availability and interpretation. The first concerns whether a participant can access the signal; the second concerns whether that participant can correctly understand, contextualise, and act upon it. This creates the possibility of informational asymmetry even when information itself is technically public. A market participant does not need exclusive access to information to possess an informational advantage. They may instead possess superior processing capabilities, better models, greater domain expertise, stronger networks, lower latency, or simply a more accurate interpretation of what the information means.
From Information Arrival to Information Diffusion
A useful way to conceptualise the process is as a sequence.
Information originates somewhere within the economic system. It is then transmitted through one or more channels, encountered by market participants, interpreted through existing beliefs and models, translated into trading decisions, and ultimately incorporated into market prices. The process is rarely linear.
For example, a fundamental research analyst may identify a development before it receives widespread attention; an institutional investor may communicate the thesis to colleagues; an analyst note may subsequently circulate among other institutions; a financial journalist may report on the development. Retail investors may encounter it through social media; algorithmic systems may detect changes in prices, volumes, language, or corporate disclosures before human investors react. As such, each stage can alter the signal.
Information can be amplified, compressed, misunderstood, delayed, contradicted, or combined with other information. By the time it reaches a large proportion of market participants, the information may have changed in meaning, or the market may have changed in response to it. Information diffusion is therefore a dynamic process rather than a simple transmission mechanism.
The Market as a Network
The diffusion model becomes particularly powerful when markets are viewed as networks.
Investors are not isolated agent; they are connected through institutions, professional relationships, research providers, media organisations, conferences, trading platforms, social networks, and information services. Some nodes within this network are considerably more connected than others. A major investment bank, influential analyst, prominent investor, financial publication, or large asset manager can occupy a structurally important position in the information network. Information passing through such nodes may reach a much larger audience than information generated by a relatively disconnected participant.
This creates an important distinction between the quality of information and the centrality of its source. A highly informative signal originating from an obscure source may diffuse slowly. On the other hand, a relatively weak signal originating from a highly influential source may diffuse rapidly. Network structure therefore influences not only how much information exists, but which information receives attention.
This is one reason markets can exhibit episodes in which certain narratives become disproportionately influential, as the underlying information may not necessarily be unprecedented. What changes is the connectivity of the network through which that information travels.
Heterogeneous Investors and Uneven Diffusion
The assumption that all investors process information identically is particularly problematic.
Market participants differ enormously in objectives, time horizons, resources, expertise, technology, incentives, and constraints. A high-frequency trading firm may respond to a signal within milliseconds; a long-term pension fund may evaluate the same information over weeks or months; a discretionary portfolio manager may require extensive fundamental research before changing a position; a retail investor may only encounter the information after it has become widely discussed. These differences produce heterogeneous diffusion speeds.
The same piece of information can therefore exist simultaneously in several informational states:
unknown to some participants
known but not understood by others
understood but considered immaterial by others
incorporated into expectations by some
reflected in prices by some but not others
The market price is consequently an aggregate outcome of multiple information-processing processes occurring at different speeds, this helps explain in part, why information can remain economically relevant even after becoming publicly available.
Information Cascades
One of the most important consequences of networked information diffusion is the emergence of information cascades.
An information cascade occurs when individuals begin to place substantial weight on the actions or beliefs of others rather than relying exclusively on their own private information. Suppose an investor observes a company announcement and initially forms a moderately positive view. They then observe several respected institutions buying the stock, their confidence increases, and other investors observe those purchases and respond in turn. The resulting buying pressure can become self-reinforcing. As at some point, participants may no longer be responding directly to the original information; they may instead be responding to the market's reaction to that information.
This creates an important feedback loop:
Information → interpretation → action → price movement → observation → reinterpretation → further action.
The market response itself becomes information, and that feedback can accelerate diffusion, but it can also distort it.
Attention as a Scarce Resource
Information diffusion is constrained by attention.
There is vastly more information available to modern investors than any individual or institution can process. The limiting factor is therefore often not information availability but the capacity to identify which information deserves attention. This creates an economic role for intermediaries. Namely, analysts, asset managers, financial media, data providers, research platforms, and increasingly automated systems act as filters within the information network. They determine which signals receive attention and which remain relatively invisible.
The market is consequently influenced not only by what information exists, but by what information becomes salient; this distinction becomes especially important during periods of heightened uncertainty. As when uncertainty rises, investors may increase their demand for information while simultaneously becoming more dependent on established information channels. Attention can become concentrated around a relatively small number of narratives, companies, indicators, or market themes.
The result can be a paradox: more information enters the system while the distribution of attention becomes narrower.
Speed, Friction and Market Efficiency
The information diffusion model provides a useful bridge between market efficiency and market friction.
The efficient market hypothesis does not require every investor to receive every piece of information simultaneously; rather, the broader proposition concerns the relationship between available information and prices. Information diffusion introduces a more granular question:
How quickly, completely, and accurately does information become incorporated into prices?
The answer depends on friction. Namely, transaction costs, liquidity constraints, short-selling restrictions, institutional mandates, leverage limits, behavioural biases, technological differences, regulatory restrictions, and organisational structures can all slow the transmission from information to action.
As even when an investor correctly identifies a mispricing, exploiting it may require capital, time, liquidity, risk tolerance, and the ability to withstand interim losses. Consequently, the existence of an informational advantage does not necessarily imply an immediately exploitable investment opportunity. The relevant question is not simply whether information has been discovered; it is whether the information has been sufficiently processed, transmitted, and acted upon by the marginal market participant.
Price Discovery as a Diffusion Process
Price discovery can therefore be understood as the visible consequence of information diffusion.
Prices aggregate heterogeneous beliefs about the future. As new information spreads, these beliefs change; and transactions occur when participants disagree sufficiently about value, expectations, or risk. The resulting price is not a perfect representation of fundamental value, but it is an equilibrium outcome generated by the interaction of information, expectations, constraints, liquidity, and behaviour. This means that price movements can contain information about the diffusion process itself.
In lieu of this, a sudden increase in volume may indicate that information has reached a previously inactive investor population. An unusual divergence between price and fundamentals may suggest that expectations have shifted faster than underlying cash flows. Likewise, persistent price momentum may reflect the gradual incorporation of information by slower-moving participants.
Price is therefore not merely an output of information processing; it is also must be treated as a signal about the state of the information network.
Diffusion, Momentum and Delayed Reaction
The information diffusion model provides one possible explanation for certain forms of return persistence.
If information is incorporated into prices gradually rather than instantaneously, investors who process information earlier may trade before investors who process it later, This can generate temporary continuation in price movements.
The mechanism is conceptually straightforward. An initial signal changes the expectations of a subset of investors; their trades move the price. Other participants subsequently observe the signal, the price movement, or both; their responses generate further price movement. Momentum can therefore emerge without requiring every investor to be irrational, as some participants may simply process information more slowly than others. This interpretation is particularly interesting because it reframes certain market anomalies as consequences of heterogeneous processing rather than straightforward violations of rationality.
Narrative Formation and Reflexivity
Information diffusion also interacts with narratives.
Investors rarely process every market event independently. They organise information into stories about growth, inflation, technological change, monetary policy, geopolitical risk, corporate strategy, or economic cycles. Narratives act as compression mechanisms; they transform large quantities of heterogeneous information into relatively simple frameworks that can guide decisions.
Once established, however, narratives can influence the very outcomes they describe. A widely accepted belief about future growth can affect capital allocation, valuations, corporate investment, hiring, financing conditions, and investor behaviour. Those changes can subsequently influence the underlying fundamentals, thus creating reflexivity. Information changes expectations, expectations change behaviour, behaviour changes economic outcomes, and those outcomes generate new information. Because of this, the information diffusion process can therefore become recursive.
Why Some Information Diffuses Faster Than Other Information
Not all information travels through markets at the same speed.
Highly salient information tends to diffuse rapidly. So does information that is easy to understand, easy to trade upon, and transmitted through highly connected networks. Information may diffuse more slowly when it is technically complex, ambiguous, difficult to verify, expensive to analyse, or dependent on long-term consequences.
This distinction is particularly important in fundamental investing. As a quarterly earnings surprise may be incorporated rapidly because its immediate numerical impact is relatively easy to evaluate; the long-term consequences of a change in industry structure however, may take much longer to understand. The market may therefore be relatively efficient at processing some dimensions of information while remaining considerably slower at processing others. As a consequence, the relevant unit of analysis is consequently not simply "the market", but the specific information-processing problem.
The Information Diffusion Model and Market Structure
Information diffusion is deeply connected to market structure.
Different markets have different levels of transparency, liquidity, participation, institutional ownership, analyst coverage, algorithmic activity, and regulatory disclosure. Large-cap equities in developed markets operate within dense information networks; whereas, smaller companies, emerging markets, private markets, and specialised securities may operate within much thinner networks. This means informational efficiency is not necessarily uniform across assets; as the same analytical framework can therefore produce very different conclusions depending on the structure through which information must travel.
A market with extensive analyst coverage and abundant liquidity may incorporate conventional information rapidly while simultaneously becoming highly competitive. A less-covered market may exhibit slower diffusion but greater informational heterogeneity. This creates a fundamental tension between information accessibility and opportunity accessibility; the existence of information therefore, is not sufficient. What matters is who can process it, when they can process it, and whether they can act upon it.
Measuring Information Diffusion
Information diffusion is difficult to observe directly because the internal beliefs of market participants are largely unobservable.
Researchers therefore rely on proxies. These can include trading volume, bid-ask spreads, price reactions, analyst revisions, institutional ownership changes, news coverage, social-media activity, order-flow measures, earnings revisions, options activity, and the temporal relationship between information events and subsequent returns.
More sophisticated approaches can model diffusion through networks. An analyst's research may be treated as an informational transmission event; institutional holdings can provide clues about network relationships; news and social-media data can provide measures of attention; changes in market microstructure can reveal shifts in participation and liquidity. The objective is not to identify a single "true" diffusion rate, it is to estimate how information propagates through the market and where frictions may exist.
Implications for Investors
For investors, the central implication is that information should not be evaluated solely according to whether it is public.
The more important questions concern processing, interpretation, timing, and saturation; an investor might ask:
What is genuinely new?
Who is likely to have noticed it?
Who is capable of understanding its implications?
How quickly can those participants act?
Which intermediaries are likely to transmit the information?
Has the market response already incorporated the most obvious interpretation?
What remains uncertain?
This shifts investment research away from simply collecting more information. The objective instead, becomes identifying where the information-processing chain remains incomplete. That can involve finding underappreciated second-order effects, distinguishing signal from narrative, identifying heterogeneous expectations, or recognising where structural constraints prevent information from being rapidly incorporated into prices. The information diffusion model therefore encourages a more sophisticated conception of informational advantage.
Advantage may arise not from knowing something nobody else knows, but from understanding something that many people know only superficially.
Limitations of the Model
The information diffusion model is useful, but it is not a complete theory of financial markets.
Information does not always produce predictable behavioural responses. Investors may receive identical information and reach radically different conclusions; moreover, markets can also experience sudden discontinuities in which information appears to be incorporated almost instantaneously.
Furthermore, diffusion does not necessarily imply mispricing, as a gradual price response can reflect rational uncertainty about the implications of new information rather than a failure of market efficiency. The model also risks becoming overly narrative if every persistent price movement is retrospectively attributed to delayed information processing, care is therefore required. information diffusion should be treated as a framework for understanding market dynamics, not as a universal explanation for every anomaly.
From Diffusion to Decision-Making
The deeper significance of the information diffusion model lies in its treatment of uncertainty.
Markets are not machines into which information is inserted and from which correct prices emerge; they are adaptive systems populated by agents with different information sets, beliefs, incentives, constraints, and processing capabilities. Information therefore has a trajectory. It originates somewhere, it travels through networks, it is filtered by attention, it is interpreted through models, it influences behaviour. Behaviour changes prices and sometimes fundamentals; and those changes create new information, beginning the process again; as such the resulting market is continuously evolving.
For investors, the challenge is consequently not to predict the exact path of information through the system. It is to understand the structure of that system well enough to identify where information is likely to be rapidly incorporated, where diffusion may be slower, and where uncertainty remains economically meaningful.
The MorMag Perspective
At MorMag, information is best understood not as a static commodity but as a dynamic process.
The distinction matters because investment research operates within an information ecosystem. Public disclosures, market prices, macroeconomic data, company fundamentals, analyst research, investor behaviour, and alternative datasets are not independent observations; they interact through networks and over time.
This creates a central research question:
Where in the information-diffusion process is the market today?
A signal may be emerging but poorly understood; it may be widely recognised but incompletely priced; it may be fully incorporated at the first-order level while its second and third-order implications remain uncertain. Alternatively, the market may have become dominated by a narrative whose diffusion has substantially exceeded the underlying evidence. These distinctions fundamentally matter for capital allocation.
MorMag's broader research philosophy therefore treats markets as probabilistic, adaptive systems rather than static collections of securities. Information diffusion sits naturally within that framework. Understanding how information moves through markets can improve the interpretation of price action, market structure, investor behaviour, and changing expectations. The objective is not to predict exactly when the market will recognise a particular fact, instead it is to understand the conditions under which information becomes economically consequential. Doing that requires looking beyond information itself and examining the network through which it travels, the agents who process it, the constraints that shape their behaviour, and the feedback loops created when their actions change the market.
In this sense, information diffusion is not merely a theory of how knowledge spreads, it is a theory of how markets learn.
Conclusion
Financial markets are often described as information-efficient because prices continuously respond to new information. But the process by which information becomes embedded in prices is neither instantaneous nor uniform.
Information moves through networks of heterogeneous participants. It is filtered by attention, interpreted through competing models, constrained by institutional structures, amplified by feedback loops, and ultimately expressed through capital allocation and prices. Understanding this process provides a richer view of market efficiency.
The important question is not simply whether information is public. Instead it is how widely it has diffused, how deeply it has been understood, how strongly it has influenced expectations, and what remains unresolved. As markets do not merely contain information; they continuously transmit, transform, and reinterpret it; and between the moment information enters the system and the moment its implications are fully reflected in collective expectations, there exists a dynamic landscape of uncertainty, behaviour, and opportunity.
