Multi-Asset Noisy Rational Expectations Equilibrium with Contingent Claims

58 Pages Posted: 8 Jun 2014 Last revised: 26 Nov 2016

Georgy Chabakauri

London School of Economics and Political Science

Kathy Yuan

London School of Economics & Political Science (LSE) - Department of Finance

Konstantinos E. Zachariadis

School of Economics and Finance, Queen Mary University of London

Date Written: November 23, 2016

Abstract

We study a noisy rational expectations equilibrium in a multi-asset economy populated by informed and uninformed investors, and noise traders. The assets can include state contingent claims such as Arrow-Debreu securities, assets with only positive payoffs, options or other derivative securities. The probabilities of states depend on a shock, which is observed only by the informed investor. We provide conditions under which the informed investor’s asset demands contain information about the shock. These conditions imply that adding derivative securities in some widely studied economies with one risky asset does not reveal any additional information about the shock. We also show that introducing volatility derivatives in incomplete markets makes these markets effectively complete, that is, allows investors to achieve Pareto optimal asset allocations. We find asset prices in closed form in (effectively) complete markets, and show that they preserve the properties of prices in incomplete markets.

Keywords: asymmetric information, rational expectations, learning from prices, contingent claims, derivative securities

JEL Classification: D82, G12, G14

Suggested Citation

Chabakauri, Georgy and Yuan, Kathy and Zachariadis, Konstantinos E., Multi-Asset Noisy Rational Expectations Equilibrium with Contingent Claims (November 23, 2016). Paris December 2015 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2446873

Georgy Chabakauri (Contact Author)

London School of Economics and Political Science ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://personal.lse.ac.uk/CHABAKAU/

Kathy Zhichao Yuan

London School of Economics & Political Science (LSE) - Department of Finance ( email )

Old Building
Houghton Street
London, London WC2A 2AE
United Kingdom
+44 (0)20 7955 6407 (Phone)
+44 (0)20 7849 4647 (Fax)

HOME PAGE: http://fmg.lse.ac.uk/~kathy

Konstantinos E. Zachariadis

School of Economics and Finance, Queen Mary University of London ( email )

Graduate Centre
Mile End Campus
London, E1 4NS
United Kingdom
+44 20 7882 8698 (Phone)

HOME PAGE: http://www.konstantinosezachariadis.com

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