Rational-Expectations Whiplash

57 Pages Posted: 17 Mar 2017 Last revised: 26 Jul 2018

See all articles by Efstathios Avdis

Efstathios Avdis

University of Alberta - Department of Finance and Statistical Analysis

Masahiro Watanabe

University of Alberta - School of Business; University of Alberta - Department of Finance and Statistical Analysis

Date Written: June 20, 2018

Abstract

We present a financial market with investors who have nested private information. Small perturbations of price informativeness, coming from distortions of dividend expectations, can trigger an oscillating shock throughout the economy that destabilizes the feedback loop between prices and expectations. Moreover, decreasing the volatility of liquidity trading makes the equilibrium less stable. We investigate what the distribution of informed investors implies for equilibrium stability and for the risk premium of the asset. We find that different investor distributions have different implications, depending on whether adverse-selection or risk-sharing effects dominate in the economy.

Keywords: Rational expectations equilibria, information hierarchy, market stability, risk premium.

JEL Classification: D82, D83, D84, G14

Suggested Citation

Avdis, Efstathios and Watanabe, Masahiro, Rational-Expectations Whiplash (June 20, 2018). University of Alberta School of Business Research Paper No. 2933935. Available at SSRN: https://ssrn.com/abstract=2933935 or http://dx.doi.org/10.2139/ssrn.2933935

Efstathios Avdis (Contact Author)

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

Masahiro Watanabe

University of Alberta - School of Business ( email )

School of Business - FMS
University of Alberta
Edmonton, Alberta T6G 2R6
Canada
780-492-7343 (Phone)
780-492-3325 (Fax)

HOME PAGE: http://www.ualberta.ca/~masa/

University of Alberta - Department of Finance and Statistical Analysis ( email )

2-32C Business Building
Edmonton, Alberta T6G 2R6
Canada

Register to save articles to
your library

Register

Paper statistics

Downloads
91
Abstract Views
537
rank
280,049
PlumX Metrics