Journal Article

Information Aggregation and Allocative Efficiency in Smooth Markets

Moallemi, Ciamac C., Iyer, Krishnamurthy, Johari, Ramesh

2014

Overview

Recent years have seen extensive investigation of the information aggregation properties of markets. However, relatively little is known about conditions under which a market will aggregate the private information of rational risk-averse traders who optimize their portfolios over time; in particular, what features of a market encourage traders to ultimately reveal their private information through trades? We consider a market model involving finitely many informed risk-averse traders interacting with a market maker. Our main result identifies a basic asymptotic smoothness condition on prices in the market that ensures information is aggregated as long as portfolios converge; furthermore, under this assumption, the allocation achieved is ex post Pareto efficient. Asymptotic smoothness is fairly mild: it requires that, eventually, infinitesimal purchases or sales should see the same per-unit price. Notably, we demonstrate that, under some mild conditions, algorithmic markets based on cost functions (or, equivalently, markets based on market scoring rules) aggregate the information of traders. This paper was accepted by Brad M. Barber, finance .

• Publisher: INFORMS,Institute for Operations Research and the Management Sciences
• Subject: Aggregation / Allocative efficiency / Asymptotic methods / Bayesian statistical decision theory / Cost functions / Economic analysis / Efficient markets / Financial portfolios / Information / information aggregation / Information analysis / Information management / Management research / Management science / Market conditions / Market prices / Market theory / Markets / Pareto efficiency / Pareto optimum / perfect Bayesian equilibrium / Portfolio analysis / Portfolio management / Portfolios / Prices / Property / Risk aversion / Sales / Scores / Stock brokers / Studies / Trade