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Noisy Arrow-Debreu Equilibria

Author

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  • Semyon MALAMUD

    (EPFL and Swiss Finance Institute)

Abstract

I develop a noisy rational expectations equilibrium model with a continuum of states and a full set of options that render the market complete. I show a major difference in equilibrium behaviour between models with constant absolute risk aversion (CARA) and non-CARA preferences. First, when informed traders have non-CARA preferences, all equilibria are fully revealing, independent of the amount of noise in the supply. Second, when informed traders have CARA preferences, but uninformed traders have non-CARA preferences, the set of equilibria contains a fully revealing equilibrium and a minimally revealing equilibrium. The latter reveals the minimal possible amount of information and is highly inefficient: In this equilibrium, Arrow-Debreu state prices are not sufficient to recover the information contained in the noisy aggregate demand and supply. My results have important implications for price discovery through options.

Suggested Citation

  • Semyon MALAMUD, 2015. "Noisy Arrow-Debreu Equilibria," Swiss Finance Institute Research Paper Series 15-09, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1509
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    More about this item

    Keywords

    asymmetric information; options; price discovery; Arrow-Debreu state prices;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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