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Privileged information exacerbates market volatility

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  • Gabriel Desgranges

    ()
    (THEMA - Théorie économique, modélisation et applications - CNRS : UMR8184 - Université de Cergy Pontoise)

  • Stéphane Gauthier

    ()
    (CES - Centre d'économie de la Sorbonne - CNRS : UMR8174 - Université Paris I - Panthéon-Sorbonne, EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)

Abstract

We study how asymmetric information affects market volatility in a linear setup where the outcome is determined by forecasts about this same outcome. The unique rational expectations equilibrium will be stable when it is the only rationalizable solution. It has been established in the literature that stability is obtained when the sensitivity of the outcome to agents' forecasts is less than 1, provided that this sensitivity is common knowledge. Relaxing this common knowledge assumption, instability is obtained when the proportion of agents who a priori know the sensitivity is large, and the uninformed agents believe it is possible that the sensitivity is greater than 1.

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Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00639813.

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Date of creation: Oct 2011
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Handle: RePEc:hal:cesptp:halshs-00639813

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Related research

Keywords: Asymmetric information; common knowledge; eductive learning; rational expectations; rationalizability; volatility.;

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  1. Nir Jaimovich & Sergio Rebelo, 2009. "Can News about the Future Drive the Business Cycle?," American Economic Review, American Economic Association, vol. 99(4), pages 1097-1118, September.
  2. David-Jan Jansen & Jakob de Haan, 2005. "Were Verbal Efforts to Support the Euro Effective? A High-Frequency Analysis of ECB Statements," DNB Working Papers, Netherlands Central Bank, Research Department 033, Netherlands Central Bank, Research Department.
  3. Jean-Michel Grandmont, 1998. "Expectations Formation and Stability of Large Socioeconomic Systems," Econometrica, Econometric Society, Econometric Society, vol. 66(4), pages 741-782, July.
  4. Christian Hellwig, . "Monetary Business Cycle Models: Imperfect Information (Review Article, March 2006)," UCLA Economics Online Papers 377, UCLA Department of Economics.
  5. Kristoffer Nimark, 2007. "Dynamic Pricing and Imperfect Common Knowledge," RBA Research Discussion Papers rdp2007-12, Reserve Bank of Australia.
  6. Pearce, David G, 1984. "Rationalizable Strategic Behavior and the Problem of Perfection," Econometrica, Econometric Society, Econometric Society, vol. 52(4), pages 1029-50, July.
  7. Stephen Morris & Hyun Song Shin, 2002. "Social Value of Public Information," American Economic Review, American Economic Association, vol. 92(5), pages 1521-1534, December.
  8. DeGennaro, Ramon P. & Shrieves, Ronald E., 1997. "Public information releases, private information arrival and volatility in the foreign exchange market," Journal of Empirical Finance, Elsevier, Elsevier, vol. 4(4), pages 295-315, December.
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