Working Paper: CEPR ID: DP2922
Authors: Piero Gottardi; Rohit Rahi
Abstract: In this paper we provide a characterization of the welfare properties of rational expectations equilibria of economies inwhich, prior to trading, agents have some information over the realization of uncertainty. We study a model withasymmetrically informed agents, treating symmetric information as a limiting case. Trade takes place in asset markets thatmay or may not be complete. We show that equilibria are characterized by two forms of inefficiency, price inefficiency andspanning inefficiency, and that generically both of them are present. Price inefficiency arises whenever equilibrium pricesreveal some information. It formalizes and generalizes the so-called Hirshleifer effect, by showing that generically aninterim Pareto improvement is possible even conditional on the information that is available to agents in equilibrium; theprimary source of the inefficiency is a pecuniary externality. Spanning inefficiency, on the other hand, arises if prices arenot fully revealing and markets are incomplete relative to the uncertainty faced by agents in equilibrium. In this case, anex-post improvement can generically be implemented by providing agents with more information, thus expanding theirrisk-sharing opportunities and reducing informational asymmetries, even though this additional information restricts the setof allocations that are incentive compatible and individually rational.
Keywords: asymmetric information; incomplete markets; rational expectations equilibrium
JEL Codes: D52; D60; D82
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Price inefficiency (D61) | interim Pareto improvements (D61) |
| Spanning inefficiency (H21) | incomplete markets (D52) |
| Asymmetric information (D82) | price inefficiency (D61) |
| Asymmetric information (D82) | spanning inefficiency (H21) |