IDEAS home Printed from https://ideas.repec.org/a/wly/emetrp/v88y2020i6p2697-2737.html
   My bibliography  Save this article

Dynamic Noisy Rational Expectations Equilibrium With Insider Information

Author

Listed:
  • Jerome Detemple
  • Marcel Rindisbacher
  • Scott Robertson

Abstract

We study equilibria in multi‐asset and multi‐agent continuous‐time economies with asymmetric information and bounded rational noise traders. We establish the existence of two equilibria. First, a full communication equilibrium where the informed agents' signal is disclosed to the market and static policies are optimal. Second, a partial communication equilibrium where the signal disclosed is affine in the informed and noise traders' signals, and dynamic policies are optimal. Here, information asymmetry creates demand for two public funds, as well as a dark pool where private information trades can be implemented. Markets are endogenously complete and equilibrium returns have a three factor structure with stochastic factors and loadings. Results are valid for constant absolute risk averse investors, general vector diffusions for fundamentals, nonlinear terminal payoffs, and non‐Gaussian noise trading. Asset price dynamics and public information flows are endogenous, and rational expectations equilibria are special cases of the general results.

Suggested Citation

  • Jerome Detemple & Marcel Rindisbacher & Scott Robertson, 2020. "Dynamic Noisy Rational Expectations Equilibrium With Insider Information," Econometrica, Econometric Society, vol. 88(6), pages 2697-2737, November.
    • Handle: RePEc:wly:emetrp:v:88:y:2020:i:6:p:2697-2737
    DOI: 10.3982/ECTA17038
    as

    Download full text from publisher

    File URL: https://doi.org/10.3982/ECTA17038
    Download Restriction: no
    File URL: https://libkey.io/10.3982/ECTA17038?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Hansen, Lars Peter & Richard, Scott F, 1987. "The Role of Conditioning Information in Deducing Testable," Econometrica, Econometric Society, vol. 55(3), pages 587-613, May.
    2. J. Michael Harrison & Stanley R. Pliska, 1981. "Martingales and Stochastic Integrals in the Theory of Continous Trading," Discussion Papers 454, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    3. Acciaio, Beatrice & Fontana, Claudio & Kardaras, Constantinos, 2016. "Arbitrage of the first kind and filtration enlargements in semimartingale financial models," Stochastic Processes and their Applications, Elsevier, vol. 126(6), pages 1761-1784.
    4. Acciaio, Beatrice & Fontana, Claudio & Kardaras, Constantinos, 2016. "Arbitrage of the first kind and filtration enlargements in semimartingale financial models," LSE Research Online Documents on Economics 65150, London School of Economics and Political Science, LSE Library.
    5. Radner, Roy, 1979. "Rational Expectations Equilibrium: Generic Existence and the Information Revealed by Prices," Econometrica, Econometric Society, vol. 47(3), pages 655-678, May.
    6. He, Hua & Wang, Jiang, 1995. "Differential Information and Dynamic Behavior of Stock Trading Volume," The Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 919-972.
    7. Dybvig, Philip H & Ross, Stephen A, 1985. "The Analytics of Performance Measurement Using a Security Market Line," Journal of Finance, American Finance Association, vol. 40(2), pages 401-416, June.
    8. Kramkov, Dmitry & Predoiu, Silviu, 2014. "Integral representation of martingales motivated by the problem of endogenous completeness in financial economics," Stochastic Processes and their Applications, Elsevier, vol. 124(1), pages 81-100.
    9. Dmitry Kramkov & Sergio Pulido, 2019. "Density of the set of probability measures with the martingale representation property," Post-Print hal-01598651, HAL.
    10. Heston, Steven L, 1993. "A Closed-Form Solution for Options with Stochastic Volatility with Applications to Bond and Currency Options," The Review of Financial Studies, Society for Financial Studies, vol. 6(2), pages 327-343.
    11. Huang, Chi-fu, 1987. "An Intertemporal General Equilibrium Asset Pricing Model: The Case of Diffusion Information," Econometrica, Econometric Society, vol. 55(1), pages 117-142, January.
    12. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, vol. 22(3), pages 477-498, June.
    13. Amendinger, Jürgen, 2000. "Martingale representation theorems for initially enlarged filtrations," Stochastic Processes and their Applications, Elsevier, vol. 89(1), pages 101-116, September.
    14. Jiang Wang, 1993. "A Model of Intertemporal Asset Prices Under Asymmetric Information," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(2), pages 249-282.
    15. Grossman, Sanford J, 1976. "On the Efficiency of Competitive Stock Markets Where Trades Have Diverse Information," Journal of Finance, American Finance Association, vol. 31(2), pages 573-585, May.
    16. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
    17. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    18. Grossman, Sanford, 1978. "Further results on the informational efficiency of competitive stock markets," Journal of Economic Theory, Elsevier, vol. 18(1), pages 81-101, June.
    19. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
    20. Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
    21. Mark P. Owen & Gordan Žitković, 2009. "Optimal Investment With An Unbounded Random Endowment And Utility‐Based Pricing," Mathematical Finance, Wiley Blackwell, vol. 19(1), pages 129-159, January.
    22. Dybvig, Philip H & Ross, Stephen A, 1985. "Differential Information and Performance Measurement Using a Security Market Line," Journal of Finance, American Finance Association, vol. 40(2), pages 383-399, June.
    23. Robert Wilson, 2005. "Information, efficiency, and the core of an economy," Studies in Economic Theory, in: Dionysius Glycopantis & Nicholas C. Yannelis (ed.), Differential Information Economies, pages 55-64, Springer.
    24. Robert M. Anderson & Roberto C. Raimondo, 2008. "Equilibrium in Continuous-Time Financial Markets: Endogenously Dynamically Complete Markets," Econometrica, Econometric Society, vol. 76(4), pages 841-907, July.
    25. Fontana, Claudio, 2018. "The strong predictable representation property in initially enlarged filtrations under the density hypothesis," Stochastic Processes and their Applications, Elsevier, vol. 128(3), pages 1007-1033.
    26. Duffie, Darrell, 1986. "Stochastic Equilibria: Existence, Spanning Number, and the 'No Expected Financial Gain from Trade' Hypothesis," Econometrica, Econometric Society, vol. 54(5), pages 1161-1183, September.
    27. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
    28. Dmitry Kramkov & Sergio Pulido, 2017. "Density of the set of probability measures with the martingale representation property," Papers 1709.07329, arXiv.org, revised Jul 2019.
    29. Cass, David & Stiglitz, Joseph E., 1970. "The structure of investor preferences and asset returns, and separability in portfolio allocation: A contribution to the pure theory of mutual funds," Journal of Economic Theory, Elsevier, vol. 2(2), pages 122-160, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Luca Bernardinelli & Paolo Guasoni & Eberhard Mayerhofer, 2022. "Informational efficiency and welfare," Mathematics and Financial Economics, Springer, volume 16, number 2, March.
    2. Detemple, Jerome & Rindisbacher, Marcel & Robertson, Scott, 2022. "Dynamic noisy rational expectations equilibrium with insider information: Welfare and regulation," Journal of Economic Dynamics and Control, Elsevier, vol. 141(C).
    3. Jerome Detemple & Scott Robertson, 2022. "Dynamic Equilibrium with Insider Information and General Uninformed Agent Utility," Papers 2211.15573, arXiv.org, revised Mar 2024.
    4. Dai, Shangze & Fan, Fei & Zhang, Keke, 2022. "Creative Destruction and Stock Price Informativeness in Emerging Economies," MPRA Paper 113661, University Library of Munich, Germany.
    5. Fabrice Baudoin & Oleksii Mostovyi, 2024. "The indifference value of the weak information," Papers 2408.02137, arXiv.org.
    6. Li, Tao, 2022. "Comments on “Dynamic noisy rational expectations equilibrium with insider information: Welfare and regulation,” by Jerome Detemple, Marcel Rindisbacher and Scott Robertson," Journal of Economic Dynamics and Control, Elsevier, vol. 141(C).
    7. Scott Robertson, 2023. "Equilibrium with Heterogeneous Information Flows," Papers 2304.01272, arXiv.org, revised Mar 2024.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Munk, Claus, 2015. "Financial Asset Pricing Theory," OUP Catalogue, Oxford University Press, number 9780198716457.
    2. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    3. Suresh M. Sundaresan, 2000. "Continuous‐Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, August.
    4. repec:dau:papers:123456789/5374 is not listed on IDEAS
    5. Basak, Suleyman, 2002. "A comparative study of portfolio insurance," Journal of Economic Dynamics and Control, Elsevier, vol. 26(7-8), pages 1217-1241, July.
    6. Jerome Detemple & Scott Robertson, 2022. "Dynamic Equilibrium with Insider Information and General Uninformed Agent Utility," Papers 2211.15573, arXiv.org, revised Mar 2024.
    7. Ayadi, Mohamed A. & Kryzanowski, Lawrence, 2005. "Portfolio performance measurement using APM-free kernel models," Journal of Banking & Finance, Elsevier, vol. 29(3), pages 623-659, March.
    8. Harrison Hong & Jiang Wang, 2000. "Trading and Returns under Periodic Market Closures," Journal of Finance, American Finance Association, vol. 55(1), pages 297-354, February.
    9. Scott Robertson, 2023. "Equilibrium with Heterogeneous Information Flows," Papers 2304.01272, arXiv.org, revised Mar 2024.
    10. DeMarzo, Peter & Skiadas, Costis, 1998. "Aggregation, Determinacy, and Informational Efficiency for a Class of Economies with Asymmetric Information," Journal of Economic Theory, Elsevier, vol. 80(1), pages 123-152, May.
    11. Tu, Teng-Tsai, 1998. "An entropic approach to equity market integration and consumption-based capital asset pricing models," ISU General Staff Papers 1998010108000012895, Iowa State University, Department of Economics.
    12. Elyès Jouini & Clotilde Napp, 2002. "Arbitrage Pricing And Equilibrium Pricing: Compatibility Conditions," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar(Volume III), chapter 6, pages 131-158, World Scientific Publishing Co. Pte. Ltd..
    13. Li, Minqiang, 2010. "Asset Pricing - A Brief Review," MPRA Paper 22379, University Library of Munich, Germany.
    14. Wayne E. Ferson & Andrew F. Siegel & Pisun (Tracy) Xu, 2005. "Mimicking Portfolios with Conditioning Information," NBER Working Papers 11020, National Bureau of Economic Research, Inc.
    15. Avdis, Efstathios, 2016. "Information tradeoffs in dynamic financial markets," Journal of Financial Economics, Elsevier, vol. 122(3), pages 568-584.
    16. Mark Broadie & Jerome B. Detemple, 2004. "ANNIVERSARY ARTICLE: Option Pricing: Valuation Models and Applications," Management Science, INFORMS, vol. 50(9), pages 1145-1177, September.
    17. Badescu, Alex & Elliott, Robert J. & Siu, Tak Kuen, 2009. "Esscher transforms and consumption-based models," Insurance: Mathematics and Economics, Elsevier, vol. 45(3), pages 337-347, December.
    18. Liu, Zhangxin (Frank) & Faff, Robert, 2017. "Hitting SKEW for SIX," Economic Modelling, Elsevier, vol. 64(C), pages 449-464.
    19. Dindo, Pietro & Massari, Filippo, 2020. "The wisdom of the crowd in dynamic economies," Theoretical Economics, Econometric Society, vol. 15(4), November.
    20. Georgy Chabakauri & Kathy Yuan & Konstantinos E Zachariadis, 2022. "Multi-asset Noisy Rational Expectations Equilibrium with Contingent Claims," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 89(5), pages 2445-2490.
    21. Björn Lutz, 2010. "Pricing of Derivatives on Mean-Reverting Assets," Lecture Notes in Economics and Mathematical Systems, Springer, number 978-3-642-02909-7, July.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wly:emetrp:v:88:y:2020:i:6:p:2697-2737. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/essssea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.