The Noise is in The Mind: Existence of Trading Equilibria with Transparent Prices

Franz Ostrizek and Elia Sartori ()
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Elia Sartori: CSEF, https://csef.it/people/elia-sartori/

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: We investigate the behavioral foundations of informed trade. We extend the canonical (Kyle, 1989) model to allow for wide range of misperception about the information environment (e.g. overconfidence and correlation delusion) as well as the market clearing condition (e.g. understatement of individual impact) and ask when a trading equilibrium can exist. We show that existence requires either i) the market clearing rule being perceived with (cognitive) noise of arbitrary size, or ii) sufficiently strong misperceptions that lead traders to overestimate the precision of their private information (relative to that of others) or underestimate their market impact. Following i) provides a cognitive foundation for the noise trader approach, while ii) yields a highly tractable linear model of (sufficiently) biased traders. Fixing the bias, a higher number of traders is beneficial for existence, though the economy is typically discontinuous in the countable-trader limit. In the latter case, equilibrium is characterized by limit uncertainty, a property which is satisfied if and only if traders perceive some correlation in their competitors’ information.

Keywords: tax compliance; enforcement; evasion; audit; disclosure; firm; bunching. (search for similar items in EconPapers)
JEL-codes: D04 D22 H24 H25 H26 H32 (search for similar items in EconPapers)
Date: 2024-07-01
New Economics Papers: this item is included in nep-acc, nep-iue, nep-mst and nep-pbe
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