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A Large-Market Rational Expectations Equilibrium Model

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  • Vives, Xavier

Abstract

This paper presents a market with asymmetric information where a privately revealing equilibrium obtains in a competitive framework and where incentives to acquire information are preserved. The equilibrium is efficient, and the paradoxes associated with fully revealing rational expectations equilibria are precluded without resorting to noise traders. The rate at which equilibria in finite replica markets with n traders approach the equilibrium in the continuum economy is 1/[square root]n, slower than the rate of convergence to price-taking behavior (1/n); and the per capita welfare loss is dissipated at the rate 1/n, slower than the rate at which inefficiency due to market power vanishes (1/n[squared]). The model admits a reinterpretation in which behavioral traders coexist with rational traders, and it allows us to characterize the amount of induced mispricing.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8426.

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Date of creation: Jun 2011
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Handle: RePEc:cpr:ceprdp:8426

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Keywords: Adverse selection; Behavioral traders; Complementarities; Double auction; Information acquisition; Multi-unit auctions; Rate of convergence;

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References

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  1. Nyborg, Kjell G. & Strebulaev, Ilya A. & Bindseil, Ulrich, 2002. "Bidding and performance in repo auctions: evidence from ECB open market operations," Working Paper Series 0157, European Central Bank.
  2. Xavier Vives, 2009. "Strategic Supply Function Competition with Private Information," Cowles Foundation Discussion Papers 1736, Cowles Foundation for Research in Economics, Yale University.
  3. Blume, Lawrence & Easley, David, 1990. "Implementation of Walrasian expectations equilibria," Journal of Economic Theory, Elsevier, vol. 51(1), pages 207-227, June.
  4. Philip J Reny & Motty Perry, 2006. "Toward a Strategic Foundation for Rational Expectations Equilibrium," Econometrica, Econometric Society, vol. 74(5), pages 1231-1269, 09.
  5. Wolfgang Pesendorfer & Jeroen M. Swinkels, 1997. "The Loser's Curse and Information Aggregation in Common Value Auctions," Econometrica, Econometric Society, vol. 65(6), pages 1247-1282, November.
  6. Cassola, Nuno & Hortacsu, Ali & Kastl, Jakub, 2011. "The 2007 subprime market crisis through the lens of European Central Bank auctions for short-term funds," Working Paper Series 1374, European Central Bank.
  7. Vives, X. & Mas-Colell, A., 1989. "Implementation in economies with a Continuum of Agents," UFAE and IAE Working Papers 129.90, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  8. De Long, J Bradford, et al, 1990. " Positive Feedback Investment Strategies and Destabilizing Rational Speculation," Journal of Finance, American Finance Association, vol. 45(2), pages 379-95, June.
  9. Wilson, Robert B, 1985. "Incentive Efficiency of Double Auctions," Econometrica, Econometric Society, vol. 53(5), pages 1101-15, September.
  10. Ewerhart, Christian & Cassola, Nuno & Valla, Natacha, 2010. "Declining valuations and equilibrium bidding in central bank refinancing operations," International Journal of Industrial Organization, Elsevier, vol. 28(1), pages 30-43, January.
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