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On the Impossibility of Informationally Efficient Markets
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In this paper, the authors propose a model in which there is an equilibrium degree of disequilibrium: prices reflect the information of informed individuals (arbitrageurs) but only partially, so that those who expend resources to obtain information do receive compensation.Abstract:
If competitive equilibrium is defined as a situation in which prices are such that all arbitrage profits are eliminated, is it possible that a competitive economy always be in equilibrium? Clearly not, for then those who arbitrage make no (private) return from their (privately) costly activity. Hence the assumptions that all markets, including that for information, are always in equilibrium and always perfectly arbitraged are inconsistent when arbitrage is costly. We propose here a model in which there is an equilibrium degree of disequilibrium: prices reflect the information of informed individuals (arbitrageurs) but only partially, so that those who expend resources to obtain information do receive compensation. How informative the price system is depends on the number of individuals who are informed; but the number of individuals who are informed is itself an endogenous variable in the model. The model is the simplest one in which prices perform a well-articulated role in conveying information from the informed to the uninformed. When informed individuals observe information that the return to a security is going to be high, they bid its price up, and conversely when they observe information that the return is going to be low. Thus the price system makes publicly available the information obtained by informed individuals to the uninformed. In general, however, it does this imperfectly; this is perhaps lucky, for were it to do it perfectly , an equilibrium would not exist. In the introduction, we shall discuss the general methodology and present some conjectures concerning certain properties of the equilibrium. The remaining analytic sections of the paper are devoted to analyzing in detail an important example of our general model, in which our conjectures concerning the nature of the equilibrium can be shown to be correct. We conclude with a discussion of the implications of our approach and results, with particular emphasis on the relationship of our results to the literature on "efficient capital markets."read more
Citations
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The Real Effects of Financial Markets
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Learning from others: A welfare analysis
TL;DR: In this article, the authors consider a smooth and noisy version of the statistical prediction model studied in the herding/informational cascades literature and compare market and optimal learning, characterized by defining a decentralized welfare benchmark as the solution to an infinite horizon team problem.
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Financial Markets Where Traders Neglect the Informational Content of Prices
TL;DR: In this paper, the authors model a financial market where some traders of a risky asset do not fully appreciate what prices convey about others' private information, and show that making private information public raises rational and "dismissive" volume, but reduces cursed volume given moderate non-informational trading motives.
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Informed Traders as Liquidity Providers: Anonymity, Liquidity and Price Formation
TL;DR: In this article, the impact of pre-trade transparency on liquidity in a market where risk-averse traders accommodate the liquidity demand of noise traders was studied, and it was shown that disclosure of traders' identities improves liquidity by mitigating adverse selection.
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Rational Attention Allocation over the Business Cycle
TL;DR: In this article, the authors argue that timing and picking are tasks, and that a skilled manager can choose how much of each task to attend to, and use tools from the rational inattention literature to show that in booms, a manger should pick stocks and in recessions, he should pay more attention to his market timing.
References
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Efficient capital markets: a review of theory and empirical work*
TL;DR: Efficient Capital Markets: A Review of Theory and Empirical Work Author(s): Eugene Fama Source: The Journal of Finance, Vol. 25, No. 2, Papers and Proceedings of the Twenty-Eighth Annual Meeting of the American Finance Association New York, N.Y. December, 28-30, 1969 (May, 1970), pp. 383-417 as mentioned in this paper
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Expectations and the neutrality of money
TL;DR: In this article, the authors provide a simple example of an economy in which equilibrium prices and quantities exhibit what may be the central feature of the modern business cycle: a systematic relation between the rate of change in nominal prices and the level of real output.
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Linear Statistical Inference and Its Applications
TL;DR: Rao's Linear Statistical Inference and Its Applications as discussed by the authors is one of the earliest works in statistical inference in the literature and has been translated into six major languages of the world.
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On the efficiency of competitive stock markets where trades have diverse information
TL;DR: In this article, the authors consider a market with two types of traders, "informed" and "uninformed" traders, and study the operation of the price system as an aggregator of different pieces of information, and show that when there are n-types of traders (n > 1), the price reveals information to each trader which is of higher quality than his own information.
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Introduction to Mathematical Statistics
TL;DR: Paul G. Hoel's “Introduction to Mathematical Statistics” seems to me to be an excellent work, and if only it can become generally available it may have a most favourable effect on the situation just described.