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Competitive Rational Expectations Equilibria Without Apology

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  • Kovalenkov, Alex
  • Vives, Xavier

Abstract

In a standard financial market model with asymmetric information with a finite number N of risk-averse informed traders, competitive rational expectations equilibria provide a good approximation to strategic equilibria as long as N is not too small: equilibrium prices in each situation converge to each other at a rate of 1/N as the market becomes large. The approximation is particularly good when the informationally adjusted risk bearing capacity of traders is not very large. This is not the case if informed traders are close to risk neutral. Both equilibria converge to the competitive equilibrium of an idealized limit continuum economy as the market becomes large at a slower rate of 1/ root N and, therefore, the limit equilibrium need not be a good approximation of the strategic equilibrium in moderately large markets.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7025.

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Date of creation: Oct 2008
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Handle: RePEc:cpr:ceprdp:7025

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Keywords: "schizophrenia" problem; free entry; information acquisition; large markets; rate of convergence; strategic equilibrium;

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References

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  1. Manzano, Carolina & Vives, Xavier, 2010. "Public and private learning from prices, strategic substitutability and complementarity, and equilibrium multiplicity," IESE Research Papers D/874, IESE Business School.
  2. Xavier Vives, 2002. "Private Information, Strategic Behavior, and Efficiency in Cournot Markets," RAND Journal of Economics, The RAND Corporation, vol. 33(3), pages 361-376, Autumn.
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Cited by:
  1. Allen, Franklin & Vayanos, Dimitri & Vives, Xavier, 2014. "Introduction to financial economics," Journal of Economic Theory, Elsevier, vol. 149(C), pages 1-14.
  2. Pasquariello, Paolo, 2014. "Prospect Theory and market quality," Journal of Economic Theory, Elsevier, vol. 149(C), pages 276-310.

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