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Testing Financial Market Equilibrium under Asymmetric Information

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  • Lang, Larry H P
  • Litzenberger, Robert H
  • Madrigal, Vicente

Abstract

The authors devise tests that distinguish between competitive (Walrasian), fully revealing rational expectations and noisy rational expectations equilibria based on their predictions concerning trading volume around public information signals. Empirical results strongly support the noisy rational expectations hypothesis. This indicates that a significant amount of noise exists (so that private information has value), but not enough to obfuscate entirely the information content of price. The authors' analysis also indicates that the dispersion of private information across traders has an impact on trading volume, but not on price. Copyright 1992 by University of Chicago Press.

Suggested Citation

  • Lang, Larry H P & Litzenberger, Robert H & Madrigal, Vicente, 1992. "Testing Financial Market Equilibrium under Asymmetric Information," Journal of Political Economy, University of Chicago Press, vol. 100(2), pages 317-348, April.
  • Handle: RePEc:ucp:jpolec:v:100:y:1992:i:2:p:317-48
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    References listed on IDEAS

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    1. Daniel Cohen & Jeffrey Sachs, 1991. "Growth and External Debt Under Risk of Debt Repudiation," NBER Chapters,in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 437-472 National Bureau of Economic Research, Inc.
    2. Rebelo, Sergio, 1991. "Long-Run Policy Analysis and Long-Run Growth," Journal of Political Economy, University of Chicago Press, pages 500-521.
    3. Robert J. Barro, 1991. "Economic Growth in a Cross Section of Countries," The Quarterly Journal of Economics, Oxford University Press, vol. 106(2), pages 407-443.
    4. Robert J. Barro & Xavier Sala-i-Martin, 1991. "Convergence across States and Regions," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, pages 107-182.
    5. Maddison, Angus, 1987. "Growth and Slowdown in Advanced Capitalist Economies: Techniques of Quantitative Assessment," Journal of Economic Literature, American Economic Association, pages 649-698.
    6. Barro, Robert J & Sala-i-Martin, Xavier, 1992. "Convergence," Journal of Political Economy, University of Chicago Press, pages 223-251.
    7. Barro, Robert J & Sala-i-Martin, Xavier, 1992. "Convergence," Journal of Political Economy, University of Chicago Press, pages 223-251.
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    Citations

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    Cited by:

    1. Huang, Roger D. & Masulis, Ronald W., 2003. "Trading activity and stock price volatility: evidence from the London Stock Exchange," Journal of Empirical Finance, Elsevier, pages 249-269.
    2. Frankel, Jeffrey A & Schmukler, Sergio L, 2000. "Country Funds and Asymmetric Information," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 5(3), pages 177-195, July.
    3. Zhou, Chunsheng, 1998. "Dynamic portfolio choice and asset pricing with differential information," Journal of Economic Dynamics and Control, Elsevier, pages 1027-1051.
    4. Lee, Yi-Tsung & Lin, Ji-Chai & Liu, Yu-Jane, 1999. "Trading patterns of big versus small players in an emerging market: An empirical analysis," Journal of Banking & Finance, Elsevier, vol. 23(5), pages 701-725, May.
    5. Selim Tuzunturk, 2009. "The relationship between volatility and volume on the Istanbul stock exchange," International Journal of Sustainable Economy, Inderscience Enterprises Ltd, pages 289-304.
    6. Juncal Cunado & Javier Gómez Biscarri & Fernando Pérez de Gracia, 2003. "Structural Changes in Volatility and Stock Market Development: Evidence for Spain," Faculty Working Papers 06/03, School of Economics and Business Administration, University of Navarra.
    7. Choi, Jong-Seo & Choe, Chongwoo, 1998. "Explanatory factors for trading volume responses to annual earnings announcements: Evidence from the Korean stock market," Pacific-Basin Finance Journal, Elsevier, pages 193-212.
    8. Gallant, A Ronald & Rossi, Peter E & Tauchen, George, 1993. "Nonlinear Dynamic Structures," Econometrica, Econometric Society, pages 871-907.
    9. Cunado Eizaguirre, Juncal & Biscarri, Javier Gomez & Hidalgo, Fernando Perez de Gracia, 2004. "Structural changes in volatility and stock market development: Evidence for Spain," Journal of Banking & Finance, Elsevier, vol. 28(7), pages 1745-1773, July.
    10. Carl Plat, 2005. "A Double Auction Market with Signals of Varying Precision," Experimental 0508004, EconWPA.
    11. Harris, Milton & Raviv, Artur, 1993. "Differences of Opinion Make a Horse Race," Review of Financial Studies, Society for Financial Studies, pages 473-506.
    12. Numan Ülkü, 2008. "Do Big Investors’ Trades Have Predictive Power? A Note on Istanbul Stock Market," Journal of BRSA Banking and Financial Markets, Banking Regulation and Supervision Agency, vol. 2(1), pages 85-108.
    13. Lang, Larry H. P. & Lee, Yi Tsung, 1999. "Performance of various transaction frequencies under call markets: The case of Taiwan," Pacific-Basin Finance Journal, Elsevier, pages 23-39.
    14. Mougoué, Mbodja & Aggarwal, Raj, 2011. "Trading volume and exchange rate volatility: Evidence for the sequential arrival of information hypothesis," Journal of Banking & Finance, Elsevier, vol. 35(10), pages 2690-2703, October.
    15. Carrera, Jose M., 1999. "Speculative attacks to currency target zones: A market microstructure approach," Journal of Empirical Finance, Elsevier, pages 555-582.

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