This study uses the theory of information transmission over communication channels to explain how supply and demand information is communicated to the public by market prices. The stock market is chosen as a specific example. Rising and falling stock prices should signal fundamental changes in the value of the underlying stocks. Excess stock price volatility occurs when stock prices change but the fundamental stock values do not. The theory of information transmission is used to show that such false price signals can be detected and thereby discounted by market traders. Successful detection leads to a more efficient market and increased social welfare by making the allocation of national resources more efficient. The theoretical market model proposed is validated using New York Stock Exchange stock price and volume data covering the historically most volatile period of this exchange. The study is important in understanding the general nature of information transmission and content. In that regard, this study explores the fundamental characteristics of information by using an engineering communications theory to analyze information flows in economic markets.
