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Endogenous Public Information and Welfare in Market Games

  • Xavier Vives

This paper performs a welfare analysis of markets with private information in which agents condition on prices in the rational expectations tradition. Price-contingent strategies introduce two externalities in the use of private information: a pecuniary externality and a learning externality. The pecuniary externality induces agents to put too much weight on private information and in the standard case, when the allocation role of the price prevails over its informational role, overwhelms the learning externality which impinges in the opposite way. The price may be very informative but at the cost of an excessive dispersion of the actions of agents. The welfare loss at the market solution may be increasing in the precision of private information. The analysis provides insights into optimal business cycle policy and a rationale for a Tobin-like tax for financial transactions.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3492.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3492
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