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An Equilibrium Model of Informed Trading and Portfolio Rebalancing

45 Pages Posted: 25 Jan 2009 Last revised: 19 Mar 2009

Jan Schneider

University of Texas at Austin - Department of Finance

Date Written: January 24, 2009

Abstract

A key intuition of standard rational expectations models is that private information about future payoffs can by itself not generate trading. Trading is only possible if there is an additional motive for trading such as for example liquidity trading. In this paper I show how this misleading intuition results from an assumption that all of these models have in common: investors have negative exponential (CARA) utility functions. I develop a rational expectations equilibrium where uninformed investors are willing to trade with informed investors even though they know that they trade with someone who possesses superior information.

Suggested Citation

Schneider, Jan, An Equilibrium Model of Informed Trading and Portfolio Rebalancing (January 24, 2009). Available at SSRN: https://ssrn.com/abstract=1332524 or http://dx.doi.org/10.2139/ssrn.1332524

Jan Schneider (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

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