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Information Revelation and Market Incompleteness

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Author Info
Marin, Jose M
Rahi, Rohit

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Abstract

This paper introduces a theory of market incompleteness based on the information transmission role of prices and its adverse impact on the provision of insurance in financial markets. We analyse a simple security design model in which the number and payoff of securities are endogenous. Agents have rational expectations and differ in information, endowments, and attitudes toward risk. When markets are incomplete, equilibrium prices are typically partially revealing, while full relevation is attained with complete markets. The optimality of complete or incomplete markets depends on whether the adverse selection effect (the unwillingness of agents to trade risks when they are informationally disadvantaged) is stronger or weaker than the Hirshleifer effect (the impossibility of trading risks that have already been resolved), as new securities are issued and prices reveal more information. When the Hirshleifer effect dominates, an incomplete set of securities is preferred by all agents, and generates a higher volume of trade. Copyright 2000 by The Review of Economic Studies Limited

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Publisher Info
Article provided by Blackwell Publishing in its journal Review of Economic Studies.

Volume (Year): 67 (2000)
Issue (Month): 3 (July)
Pages: 563-79
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Handle: RePEc:bla:restud:v:67:y:2000:i:3:p:563-79

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  1. Juan Hatchondo, 2004. "The value of information with heterogeneous agents and partially revealing prices," Econometric Society 2004 North American Summer Meetings 175, Econometric Society. [Downloadable!]
  2. José M. Marín & Jacques Olivier, 2007. "The dog that did not bark: Insider trading and crashes," Working Papers 2007-20, Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales. [Downloadable!]
    Other versions:
  3. Acharya, Viral V & Johnson, Tim, 2005. "Insider Trading in Credit Derivatives," CEPR Discussion Papers 5180, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  4. Bhagwan Chowdhry & Mark Grinblatt & David Levine, 2002. "Information Aggregation, Security Design and Currency Swaps," NBER Working Papers 8746, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Marc-Andreas Muendler, 2005. "The Action Value of Information and the Natural Transparency Limit¤," University of California at San Diego, Economics Working Paper Series 2005-09, Department of Economics, UC San Diego. [Downloadable!]
  6. Bhagwan Chowdhry & Mark Grinblatt & David K Levine, 2001. "Information Aggregation, Currency Swaps, and the Design of Derivative Securities," Levine's Working Paper Archive 2106, UCLA Department of Economics. [Downloadable!]
    Other versions:
  7. Juan Carlos Hatchondo, 2005. "The value of information with heterogeneous agents and partially revealing prices," Working Paper 05-06, Federal Reserve Bank of Richmond. [Downloadable!]
  8. José M. Marín & Rohit Rahi, 1997. "Speculative Securities," Economics Working Papers 223, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
    Other versions:
  9. Ronel Elul & Piero Gottardi, 2007. "Bankruptcy: Is it enough to forgive or must we also forget?," Working Papers 07-10, Federal Reserve Bank of Philadelphia. [Downloadable!]
    Other versions:
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