Multiple Equilibria in Dynamic Models of Informed Trade
15 Pages Posted: 31 Jan 2013
Date Written: June 11, 2003
Dynamic models of competitive informed trading usually have multiple equilibria. Typically, the literature proceeds by studying one equilibrium which is chosen without any further justification. In the setup of Hirshleifer, Subrahmanyam, and Titman (1994) we document how the two equilibria the authors find differ. As the number of informed traders goes to zero, the equilibrium the authors study becomes progressively less informative. The other equilibrium, however, displays strikingly counterintuitive behavior. With fewer informed agents present in the market, prices become increasingly informative. In the limit, the stock price fully reflects information that is unavailable to anyone in the economy. While the second case seems counterintuitive, there is no economic reason why one equilibrium should obtain and not the other.
Keywords: multiple equilibria, noisy rational expectations
JEL Classification: G10, G14
Suggested Citation: Suggested Citation