Welfare Consequences of Information Aggregation and Optimal Market Size†

Welfare Consequences of Information Aggregation and Optimal Market Size† AbstractWe analyze the welfare implications of information aggregation in a trading model where traders have both idiosyncratic endowment risk and asymmetric information about security payoffs. The optimal market size balances two forces: (i) the risk-sharing role of markets, which creates a positive externality amongst traders, against (ii) the information-aggregation role of prices, which leads to prices that are more correlated with security payoffs, thereby undermining the hedging function of markets. Our analysis indicates that a market with infinitely many traders may not be the right welfare benchmark in the presence of risk aversion and information aggregation. (JEL D43, D62, D82, D83) http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png American Economic Journal: Microeconomics American Economic Association

Welfare Consequences of Information Aggregation and Optimal Market Size†

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Publisher
American Economic Association
Copyright
Copyright © 2017 © American Economic Association
ISSN
1945-7685
D.O.I.
10.1257/mic.20160010
Publisher site
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Abstract

AbstractWe analyze the welfare implications of information aggregation in a trading model where traders have both idiosyncratic endowment risk and asymmetric information about security payoffs. The optimal market size balances two forces: (i) the risk-sharing role of markets, which creates a positive externality amongst traders, against (ii) the information-aggregation role of prices, which leads to prices that are more correlated with security payoffs, thereby undermining the hedging function of markets. Our analysis indicates that a market with infinitely many traders may not be the right welfare benchmark in the presence of risk aversion and information aggregation. (JEL D43, D62, D82, D83)

Journal

American Economic Journal: MicroeconomicsAmerican Economic Association

Published: Nov 1, 2017

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