Discussion Paper Details

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Title: A Large-Market Rational Expectations Equilibrium Model

Author(s): Xavier Vives

Publication Date: June 2011

Keyword(s): Adverse selection, Behavioral traders, Complementarities, Double auction, Information acquisition, Multi-unit auctions and Rate of convergence

Programme Area(s): Financial Economics and Industrial Organization

Abstract: This paper presents a market with asymmetric information where a privately revealing equilibrium obtains in a competitive framework and where incentives to acquire information are preserved. The equilibrium is efficient, and the paradoxes associated with fully revealing rational expectations equilibria are precluded without resorting to noise traders. The rate at which equilibria in finite replica markets with n traders approach the equilibrium in the continuum economy is 1/[square root]n, slower than the rate of convergence to price-taking behavior (1/n); and the per capita welfare loss is dissipated at the rate 1/n, slower than the rate at which inefficiency due to market power vanishes (1/n[squared]). The model admits a reinterpretation in which behavioral traders coexist with rational traders, and it allows us to characterize the amount of induced mispricing.

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Bibliographic Reference

Vives, X. 2011. 'A Large-Market Rational Expectations Equilibrium Model'. London, Centre for Economic Policy Research.