Competitive rational expectations equilibria without apology
The authors consider \textit{A. S. Kyle}'s model of a market of a single risky asset that is traded among noise traders, \(N\) informed speculators, and market makers [Rev. Econ. Stud. 56, No. 3, 317--355 (1989; Zbl 0669.90016)]. Their aim is ``to find out conditions under which one can safely use competitive rational expectations equilibria (REE) as an approximation of the `true' strategic equilibria (Nash equilibria). Speculators' information, generating asymmetry, are private signals about the realization of an asset's liquidation value. A speculator chooses a demand schedule which depends on his private information and derives utility which depends on the return of asset trading. ``When \(N\) grows at the same rate as noise trading, prices in competitive and in strategic REE converge to each other at a rate of \(1/N\). Equilibria in the two scenarios are close when noise trading volume per informed trader is large in relation to risk-bearing capacity. Both equilibria converge to the competitive equilibrium of a limit continuum economy as the market becomes large at a slower rate of \(1/pN\). The results extend to endogenous information acquisition and the connections with the Grossman-Stiglitz paradox are highlighted.
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