Informationally Efficient Markets in Grossman and Stiglitz (1980)

38 Pages Posted: 8 May 2014

See all articles by Hui Ou-Yang

Hui Ou-Yang

Cheung Kong Graduate School of Business

Weili Wu

Central University of Finance and Economics (CUFE)

Date Written: March 1, 2014

Abstract

We derive an equilibrium price that converges to be strong-form informationally efficient in the original Grossman-Stiglitz model (1980). Specifically, we show that when the private signal converges to be perfect or traders converge to be risk neutral, there exists a unique overall equilibrium for any finite information costs in which the price tends to be strong-form efficient. We further find that when the price tends to be fully revealing, informed and uninformed traders have almost homogeneous beliefs about the stock payoff, but there are still significant trades between them. We thus provide an economically meaningful resolution to the Grossman-Stiglitz paradox.

Keywords: Informationally efficient markets; Grossman-Stiglitz paradox; Competitive markets

JEL Classification: G10; G12, G14

Suggested Citation

Ou-Yang, Hui and Wu, Weili, Informationally Efficient Markets in Grossman and Stiglitz (1980) (March 1, 2014). Available at SSRN: https://ssrn.com/abstract=2433662 or http://dx.doi.org/10.2139/ssrn.2433662

Hui Ou-Yang (Contact Author)

Cheung Kong Graduate School of Business ( email )

Hong Kong
China
852-5199-6227 (Phone)

Weili Wu

Central University of Finance and Economics (CUFE) ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

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