Informationally Efficient Markets in Grossman and Stiglitz (1980)

Abstract

We derive an equilibrium price that converges to be strong-form informationally efficient in the original Grossman-Stiglitz model (1980). Specifically, we show that when the private signal converges to be perfect or traders converge to be risk neutral, there exists a unique overall equilibrium for any finite information costs in which the price tends to be strong-form efficient. We further find that when the price tends to be fully revealing, informed and uninformed traders have almost homogeneous beliefs about the stock payoff, but there are still significant trades between them. We thus provide an economically meaningful resolution to the Grossman-Stiglitz paradox.

Keywords: Informationally efficient markets; Grossman-Stiglitz paradox; Competitive markets

JEL Classification: G10; G12, G14