On the Co-Evolution of Insider Information and Idiosyncratic Beliefs

Abstract

In a market with stochastic demand at most one seller can acquire costly information about demand. Other sellers entertain idiosyncratic beliefs about the market demand and whether there exists an informed seller. These idiosyncratic beliefs co-evolve with the potential insider's inclination to acquire information.

True demand expectations are not evolutionarily stable when beliefs, via revelation, can be used to commit to more aggressive behavior. The commitment effect fades away in large markets and has the same direction for for both strategic substitutes and complements. Whether one observes an insider, in the long haul, depends on the information costs. For strategic substitutes insider activity benefits the whole population when it is possible that the uniformed sellers gain more than the insider.

Keywords: co-evolution, idiosyncratic beliefs, inside information, heterogenous markets, information sharing

JEL Classification: C79, D43, D82