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Common Knowledge of Rationality and Market Clearing in Economies with Asymmetric Information

Author

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  • Elchanan Ben-Porath
  • Aviad Heifetz

Abstract

Consider an exchange economy with asymmetric information. What is the set of outcomes that are consistent with common knowledge of rationality and market clearing? To address this question we define an epistemic model for the economy that provides a complete description not only of the beliefs of each agent on the relationship between states of nature and prices but also of the whole system of interactive beliefs. The main result, theorem 1, provides a characterization of outcomes that are consistent with common knowledge of rationality and market clearing (henceforth, CKRMC outcomes) in terms of a solution notion - Ex - Post Rationalizability - that is defined directly in terms of the parameters that define the economy. We then apply theorem 1 to characterize the set of CKRMC outcomes in a general class of economies with two commodities. CKRMC manifests several intuitive properties that stand in contrast to the full revelation property of Rational Expectations Equilibrium: In particular, we obtain that for a robust class of economies: (1) there is a continuum of prices that are consistent with CKRMC in every state of nature, and hence these prices do not reveal the true state, (2) the range of CKRMC outcomes is monotonically decreasing as agents become more informed about the economic fundamentals, and (3) trade is consistent with common knowledge of rationality and market clearing even when there is common knowledge that there are no mutual gains from trade.

Suggested Citation

  • Elchanan Ben-Porath & Aviad Heifetz, 2010. "Common Knowledge of Rationality and Market Clearing in Economies with Asymmetric Information," Discussion Papers 1487, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    • Handle: RePEc:nwu:cmsems:1487
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    Cited by:

    1. Ayan Bhattacharya, 2022. "Arbitrage from a Bayesian's Perspective," Papers 2211.03244, arXiv.org.
    2. Samuli Reijula & Jaakko Kuorikoski & Timo Ehrig & Konstantinos Katsikopoulos & Shyam Sunder, 2018. "Nudge, Boost, or Design? Limitations of behaviorally informed policy under social interaction," Journal of Behavioral Economics for Policy, Society for the Advancement of Behavioral Economics (SABE), vol. 2(1), pages 99-105, March.
    3. Lionel de Boisdeffre, 2025. "Equilibrium with asymmetric information and restricted participation: The no-arbritrage characterization," Documents de travail du Centre d'Economie de la Sorbonne 25014, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
    4. Lukasz Balbus & Michael Greinecker & Kevin Reffett & Lukasz Wozny, 2025. "Interim correlated rationalizability in large games," Papers 2506.18426, arXiv.org.
    5. de Boisdeffre, Lionel, 2022. "Dropping rational expectations," Mathematical Social Sciences, Elsevier, vol. 115(C), pages 37-46.

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    Keywords

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    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General

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