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Multi-asset Noisy Rational Expectations Equilibrium with Contingent Claims
[A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets]

Author

Listed:
  • Georgy Chabakauri
  • Kathy Yuan
  • Konstantinos E Zachariadis

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 an aggregate shock, which is observed only by the informed investor. We derive a three-factor CAPM with asymmetric information, establish conditions under which asset prices reveal information about the shock, and show that information asymmetry amplifies the effects of payoff skewness on asset returns. We also find that volatility derivatives make incomplete markets effectively complete, and their prices quantify market illiquidity and shadow value of information to uninformed investors.

Suggested Citation

  • Georgy Chabakauri & Kathy Yuan & Konstantinos E Zachariadis, 2022. "Multi-asset Noisy Rational Expectations Equilibrium with Contingent Claims [A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 89(5), pages 2445-2490.
    • Handle: RePEc:oup:restud:v:89:y:2022:i:5:p:2445-2490.
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    File URL: http://hdl.handle.net/10.1093/restud/rdab081
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    References listed on IDEAS

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    1. Kathy Yuan, 2005. "Asymmetric Price Movements and Borrowing Constraints: A Rational Expectations Equilibrium Model of Crises, Contagion, and Confusion," Journal of Finance, American Finance Association, vol. 60(1), pages 379-411, February.
    2. Matthijs Breugem & Adrian Buss, 2019. "Institutional Investors and Information Acquisition: Implications for Asset Prices and Informational Efficiency," Review of Financial Studies, Society for Financial Studies, vol. 32(6), pages 2260-2301.
    3. Bernardo, Antonio E. & Judd, Kenneth L., 2000. "Asset market equilibrium with general tastes, returns, and informational asymmetries," Journal of Financial Markets, Elsevier, vol. 3(1), pages 17-43, February.
    4. Back, Kerry, 1993. "Asymmetric Information and Options," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 435-472.
    5. Jiang Wang, 1993. "A Model of Intertemporal Asset Prices Under Asymmetric Information," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(2), pages 249-282.
    6. Kurlat, Pablo & Veldkamp, Laura, 2015. "Should we regulate financial information?," Journal of Economic Theory, Elsevier, vol. 158(PB), pages 697-720.
    7. Grossman, Sanford J, 1976. "On the Efficiency of Competitive Stock Markets Where Trades Have Diverse Information," Journal of Finance, American Finance Association, vol. 31(2), pages 573-585, May.
    8. Gregor Andrade & Steven N. Kaplan, 1998. "How Costly is Financial (Not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed," Journal of Finance, American Finance Association, vol. 53(5), pages 1443-1493, October.
    9. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
    10. Amershi, Amin H, 1985. "A Complete Analysis of Full Pareto Efficiency in Financial Markets for Arbitrary Preferences," Journal of Finance, American Finance Association, vol. 40(4), pages 1235-1243, September.
    11. Bradyn Breon-Drish, 2015. "On Existence and Uniqueness of Equilibrium in a Class of Noisy Rational Expectations Models," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 82(3), pages 868-921.
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    Cited by:

    1. Christian Keller & Michael C. Tseng, 2023. "Arrow-Debreu Meets Kyle: Price Discovery for Derivatives," Papers 2302.13426, arXiv.org, revised Mar 2024.

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    More about this item

    Keywords

    Asymmetric information; Learning from prices; Multi-asset economy;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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