Toward a Strategic Foundation for Rational Expectations Equilibrium

University Of Chicago, Chicago IL

Investigators

Abstract

This research seeks to understand whether large markets (i.e., markets consisting of many buyers and many sellers) can effectively aggregate the disparate pieces of information that each individual acting in the market possesses. It is often said that prices "convey" information. How, exactly, is this achieved? Under what conditions is it achieved? Stock markets are a prime example of markets in which information plays a crucial role. When information is freely available to all, it is well understood that markets operate efficiently. But in reality each investor possesses a small amount of information, which, on its own, might convey little about the value of the stock in question. However, if the information possessed by all traders could somehow be pooled, it would serve as a much better forecaster of the value of the stock. We seek to understand whether market prices alone are capable of conveying the information possessed by individual traders. When this occurs, the market achieves a high level of efficiency. When this fails to occur, one can begin to explore ways in which the market's design might be responsible for the failure. Corrective measures might then be called for.