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Efficiency Properties of Rational Expectations Equilibria with Asymmetric Information

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  • Gottardi, Piero
  • Rahi, Rohit

Abstract

In this paper we provide a characterization of the welfare properties of rational expectations equilibria of economies in which, prior to trading, agents have some information over the realization of uncertainty. We study a model with asymmetrically informed agents, treating symmetric information as a limiting case. Trade takes place in asset markets that may or may not be complete. We show that equilibria are characterized by two forms of inefficiency, price inefficiency and spanning inefficiency, and that generically both of them are present. Price inefficiency arises whenever equilibrium prices reveal some information. It formalizes and generalizes the so-called Hirshleifer effect, by showing that generically an interim Pareto improvement is possible even conditional on the information that is available to agents in equilibrium; the primary source of the inefficiency is a pecuniary externality. Spanning inefficiency, on the other hand, arises if prices are not fully revealing and markets are incomplete relative to the uncertainty faced by agents in equilibrium. In this case, an ex-post improvement can generically be implemented by providing agents with more information, thus expanding their risk-sharing opportunities and reducing informational asymmetries, even though this additional information restricts the set of allocations that are incentive compatible and individually rational.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2922.

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Date of creation: Aug 2001
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Handle: RePEc:cpr:ceprdp:2922

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Keywords: Asymmetric Information; Incomplete Markets; Rational Expectations Equilibrium;

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References

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  1. FORGES, Françoise, . "Posterior efficiency," CORE Discussion Papers RP -1077, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  2. Bengt Holmstrom & Roger B. Myerson, 1981. "Efficient and Durable Decision Rules with Incomplete Information," Discussion Papers 495, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Postlewaite, Andrew & Schmeidler, David, 1986. "Implementation in differential information economies," Journal of Economic Theory, Elsevier, vol. 39(1), pages 14-33, June.
  4. Stiglitz, Joseph E, 1982. "The Inefficiency of the Stock Market Equilibrium," Review of Economic Studies, Wiley Blackwell, vol. 49(2), pages 241-61, April.
  5. Tom Krebs, 1999. "Information and Efficiency in Financial Market Equilibrium," Working Papers 99-20, Brown University, Department of Economics.
  6. Gul, Faruk & Postlewaite, Andrew, 1992. "Asymptotic Efficiency in Large Exchange Economies with Asymmetric Information," Econometrica, Econometric Society, vol. 60(6), pages 1273-92, November.
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Cited by:
  1. Piero Gottardi & Rohit Rahi, 2007. "Value of information in competitive economies with incomplete markets," LSE Research Online Documents on Economics 4749, London School of Economics and Political Science, LSE Library.
  2. Juan Hatchondo, 2004. "The value of information with heterogeneous agents and partially revealing prices," Econometric Society 2004 North American Summer Meetings 175, Econometric Society.

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