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Rational expectations equilibrium with transaction costs in financial markets

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  • Chong, Zhiwei

Abstract

We obtain a closed-form solution to rational expectations equilibrium with transaction costs in the framework of Grossman and Stiglitz (1980) [On the impossibility of informationally efficient markets. American Economic Review 70, 543-566]. Individual private information incorporated into prices is reduced due to suppressed trading activities by transaction costs. The equilibrium fraction of informed traders increases (decreases) with transaction costs when the costs are low (high). The informativeness of prices decreases with transaction costs.

Suggested Citation

  • Chong, Zhiwei, 2010. "Rational expectations equilibrium with transaction costs in financial markets," MPRA Paper 34444, University Library of Munich, Germany, revised 14 Jul 2011.
    • Handle: RePEc:pra:mprapa:34444
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    References listed on IDEAS

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    4. George M. Constantinides, 2005. "Capital Market Equilibrium with Transaction Costs," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 7, pages 207-227, World Scientific Publishing Co. Pte. Ltd..
    5. Heaton, John & Lucas, Deborah J, 1996. "Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 443-487, June.
    6. repec:bla:jfinan:v:59:y:2004:i:1:p:289-338 is not listed on IDEAS
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    More about this item

    Keywords

    rational expectations; transaction cost; information acquisition;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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