Wednesday, April 11, 2012
Bray Theory Workshop
A Large-Market Rational Expectations Equibrium Model
Xavier Vives, Professor of Economics and Finance, IESE
This paper presents conditions for a resolution of the Grossman-Stiglitz paradox of informationally efficient markets. We display a market with asymmetric information where a privately revealing equilibrium obtains in a competitive framework and where incentives to acquire information are preserved as long as the common value component of traders' valuations is not too high. The equilibrium is efficient, and the problems associated with fully revealing rational expectations equilibria are precluded without resorting to noise traders. The model admits a reinterpretation in which behavioral traders coexist with rational traders, and it allows us to characterize the amount of induced mispricing.
A copy of the paper can be found at: http://www.iese.edu/research/pdfs/DI-0924-E.pdf