Noisy Arrow-Debreu Equilibria

Semyon Malamud
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Semyon Malamud: EPFL and Swiss Finance Institute

No 15-09, Swiss Finance Institute Research Paper Series from 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.

Keywords: asymmetric information; options; price discovery; Arrow-Debreu state prices (search for similar items in EconPapers)
JEL-codes: D82 G13 G14 (search for similar items in EconPapers)
Pages: 50 pages
Date: 2015-02
New Economics Papers: this item is included in nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1509

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