Efficiency Properties of Rational Expectations Equilibria with Asymmetric Information

47 Pages Posted: 28 Aug 2001

See all articles by Piero Gottardi

Piero Gottardi

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

Rohit Rahi

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

Multiple version iconThere are 2 versions of this paper

Date Written: August 2001

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.

Keywords: Asymmetric information, incomplete markets, rational expectations equilibrium

JEL Classification: D52, D60, D82

Suggested Citation

Gottardi, Piero and Rahi, Rohit, Efficiency Properties of Rational Expectations Equilibria with Asymmetric Information (August 2001). Available at SSRN: https://ssrn.com/abstract=281396

Piero Gottardi (Contact Author)

University of Essex - Department of Economics ( email )

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom

European University Institute - Department of Economics ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

Ca Foscari University of Venice - Dipartimento di Economia ( 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

Rohit Rahi

London School of Economics - Department of Finance ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
+44 20 7955 7313 (Phone)

HOME PAGE: http://https://sites.google.com/lse.ac.uk/rohit-rahi

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
19
Abstract Views
1,679
PlumX Metrics