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Efficiency Properties of Rational Expectations Equilibria with Asymmetric Information


Rohit Rahi


London School of Economics - Department of Finance; London School of Economics & Political Science (LSE) - Financial Markets Group

Piero Gottardi


European University Institute - Department of Economics; Ca Foscari University of Venice - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

June 2001

LSE Financial Markets Group Working Paper No. 381

Abstract:     
In this paper we provide a characterization of the welfare properties of rational expectations equilibria of economies in which, prior to trading, agents have some information over the realization of uncertainty. We study a model with asymmetrically informed agents, treating symmetric information as a limiting case. Trade takes place in asset markets that may or may not be complete. We show that equilibria are characterized by two forms of inefficiency, price inefficiency and spanning inefficiency, and that generically both of them are present. Price inefficiency arises whenever equilibrium prices reveal some information. It formalizes and generalizes the so-called Hirshleifer effect, by showing that generically an interim Pareto improvement is possible even conditional on the information that is available to agents in equilibrium; the primary source of the inefficiency is a pecuniary externality. Spanning inefficiency, on the other hand, arises if prices are not fully revealing and markets are incomplete relative to the uncertainty faced by agents in equilibrium. In this case, an ex-post improvement can generically be implemented by providing agents with more information, thus expanding their risk-sharing opportunities and reducing informational asymmetries, even though this additional information restricts the set of allocations that are incentive compatible and individually rational.

Number of Pages in PDF File: 45

Keywords: Rational Expectations Equilibrium, Asymmetric Information, Incomplete Markets

JEL Classification: D52, D60, D82

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Date posted: July 28, 2001  

Suggested Citation

Rahi, Rohit and Gottardi, Piero, Efficiency Properties of Rational Expectations Equilibria with Asymmetric Information (June 2001). LSE Financial Markets Group Working Paper No. 381. Available at SSRN: http://ssrn.com/abstract=277371 or http://dx.doi.org/10.2139/ssrn.277371

Contact Information

Rohit Rahi (Contact Author)
London School of Economics - Department of Finance ( email )
Houghton Street
London, WC2A 2AE
United Kingdom
+44 20 7955 7313 (Phone)
+44 20 7955 7420 (Fax)
HOME PAGE: http://vishnu.lse.ac.uk/
London School of Economics & Political Science (LSE) - Financial Markets Group ( email )
Houghton Street
London WC2A 2AE
United Kingdom
Piero Gottardi
European University Institute - Department of Economics ( email )
Villa Schifanoia
133 via Bocaccio
Firenze (Florence), 50014
Italy
Ca Foscari University of Venice - Department of Economics ( email )
Cannaregio 873
Venice, 30121
Italy
+39 041 257 4192 (Phone)
+39 041 257 4176 (Fax)
CESifo (Center for Economic Studies and Ifo Institute)
Poschinger Str. 5
Munich, DE-81679
Germany
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