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How Equilibrium Prices Reveal Information in Time Series Models with Disparately Informed, Competitive Traders

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Author Info

  • Todd B. Walker

    (University of Iowa)

Abstract

Accommodating asymmetric information in a dynamic asset pricing model is technically challenging due to the problems associated with higher-order expectations. That is, rational investors are forced into a situation where they must forecast the forecasts of other agents (i.e., form higher-order expectations). In a dynamic setting, this problem telescopes into the infinite future and the dimension of the relevant state space approaches infinity. By employing the frequency domain approach of Whiteman (1983) and Kasa (2000), this paper demonstrates how information structures previously believed to lead to disparate expectations in equilibrium (e.g., Singleton (1987)) converge to a symmetric equilibrium. The “revealing” aspect of the price process lies in the invertibility of the observed state space, which makes it possible for agents to infer the economically fundamental shocks, thus eliminating the need to forecast the forecasts of others.

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File URL: http://128.118.178.162/eps/fin/papers/0509/0509021.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Finance with number 0509021.

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Length: 33 pages
Date of creation: 18 Sep 2005
Date of revision:
Handle: RePEc:wpa:wuwpfi:0509021

Note: Type of Document - pdf; pages: 33
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Web page: http://128.118.178.162

Related research

Keywords: Asymmetric Information; Asset Pricing; Frequency Domain;

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References

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  1. Futia, Carl A, 1981. "Rational Expectations in Stationary Linear Models," Econometrica, Econometric Society, vol. 49(1), pages 171-92, January.
  2. Townsend, Robert M, 1983. "Forecasting the Forecasts of Others," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 546-88, August.
  3. Franklin Allen & Stephen Morris & Hyun Song Shin, 2003. "Beauty Contests, Bubbles and Iterated Expectations in Asset Markets," Cowles Foundation Discussion Papers 1406, Cowles Foundation for Research in Economics, Yale University.
  4. Kenneth Kasa, 2000. "Forecasting the Forecasts of Others in the Frequency Domain," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(4), pages 726-756, October.
  5. Hua He & Jiang Wang, 1995. "Differential Information and Dynamic Behavior of Stock Trading Volume," NBER Working Papers 5010, National Bureau of Economic Research, Inc.
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  7. Marco Lippi & Lucrezia Reichlin, 1994. "VAR analysis, non-fundamental representations, Blashke matrices," ULB Institutional Repository 2013/10151, ULB -- Universite Libre de Bruxelles.
  8. Joseph G. Pearlman & Thomas J. Sargent, 2005. "Knowing the Forecasts of Others," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(2), pages 480-497, April.
  9. Foster, F Douglas & Viswanathan, S, 1996. " Strategic Trading When Agents Forecast the Forecasts of Others," Journal of Finance, American Finance Association, vol. 51(4), pages 1437-78, September.
  10. Lucas, Robert Jr., 1972. "Expectations and the neutrality of money," Journal of Economic Theory, Elsevier, vol. 4(2), pages 103-124, April.
  11. Pearlman, Joseph & Currie, David & Levine, Paul, 1986. "Rational expectations models with partial information," Economic Modelling, Elsevier, vol. 3(2), pages 90-105, April.
  12. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  13. Michael Woodford, 2001. "Imperfect Common Knowledge and the Effects of Monetary Policy," NBER Working Papers 8673, National Bureau of Economic Research, Inc.
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Cited by:
  1. Bacchetta, Philippe & van Wincoop, Eric, 2008. "Higher Order Expectations in Asset Pricing," CEPR Discussion Papers 6648, C.E.P.R. Discussion Papers.
  2. Pengfei Wang & Yi Wen, 2007. "Incomplete information and self-fulfilling prophecies," Working Papers 2007-033, Federal Reserve Bank of St. Louis.

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