Efficiency Properties of Rational Expectations Equilibria with Asymmetric Information
We analyze the welfare properties of rational expectations equilibria (REE) in economies with asymmetrically informed agents and incomplete markets. We ask whether a planner can improve upon an equilibrium allocation, using an individually rational and incentive compatible mechanism, and subject to the same asset constraints as agents. For an REE that reveals any information at all, the planner can generically bring about an interim Pareto improvement even conditional on the information that is available to agents in equilibrium. He can do so by altering prices while keeping their informational content fixed. Furthermore, for any partially revealing equilibrium, the planner can generically effect an ex post Pareto improvement by providing more information to agents, while controlling for price effects.
In this paper we provide a characterization of the welfare properties of rational expectations equilibria of economies in which, prior to trading, agents have some information over the realization of uncertainity. We study a model with asymmetrically informed agents, treating symmetric information as a limiting case. Trade takes place in asset markets that may or may not be complete. We show that equilibria are characterized by two forms of inefficiency, price inefficiency and spanning inefficiency, and that generically both of them are present. Price inefficiency arises whenever equilibrium prices reveal some information. It formalizes and generalizes the so-called Hirshleifer effect, by showing that generically an interim Pareto improvement is possible even conditional on the information that is available to agents in equilibrium; the primary source of the inefficiency is a pecuniary externality. Spanning ineffiency, on the other hand, arises if prices are not fully revealing and markets are incomplete relative to the uncertainity faced by agents in equilibrium. In this case, an ex-post improvement can generically be implemented by providing agents with more information, thus expanding their risk-sharing opportunities and reducing informational asymmetries, even though this additional information restricts the set of allocations that are incentive compatible and individually rational.
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