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Rational expectations equilibrium with uncertain proportion of informed traders

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  • Gao, Feng
  • Song, Fengming
  • Wang, Jun
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    Abstract

    This paper introduces uncertainty regarding the proportion of informed traders in a rational expectation equilibrium model with asymmetric information. The proportion uncertainty dramatically changes the properties of the resulting equilibrium. First, it may generate multiple nonlinear rational expectations equilibria, which can help explain the excessive volatility of stock prices. Second, the expected price informativeness is a non-monotonic function of the proportion of informed traders, which suggests that the traders will have more incentive to become informed as the proportion of informed traders gets larger.

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    File URL: http://www.sciencedirect.com/science/article/pii/S138641811200016X
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Markets.

    Volume (Year): 16 (2013)
    Issue (Month): 3 ()
    Pages: 387-413

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    Handle: RePEc:eee:finmar:v:16:y:2013:i:3:p:387-413

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    Web page: http://www.elsevier.com/locate/finmar

    Related research

    Keywords: Nonlinear rational expectations equilibrium; Asymmetric information; Multiplicity; Complementarity;

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    References

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    12. Jayant Vivek Ganguli & Liyan Yang, 2009. "Complementarities, Multiplicity, and Supply Information," Journal of the European Economic Association, MIT Press, vol. 7(1), pages 90-115, 03.
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    17. Biais, Bruno & Bossaerts, Peter & Spatt, Chester, 2009. "Equilibrium Asset Pricing and Portofolio Choice Under Asymmetric Information," IDEI Working Papers 474, Institut d'Économie Industrielle (IDEI), Toulouse.
    18. Sims, Christopher A., 2003. "Implications of rational inattention," Journal of Monetary Economics, Elsevier, vol. 50(3), pages 665-690, April.
    19. Avery, Christopher & Zemsky, Peter, 1998. "Multidimensional Uncertainty and Herd Behavior in Financial Markets," American Economic Review, American Economic Association, vol. 88(4), pages 724-48, September.
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    Cited by:
    1. Hatchondo, Juan Carlos & Krusell, Per & Schneider, Martin, 2014. "Asset Trading and Valuation with Uncertain Exposure," Working Paper 14-5, Federal Reserve Bank of Richmond.

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