Testing Financial Market Equilibrium under Asymmetric Information

Abstract

We devise tests that distinguish between competitive (Walrasian), fully revealing rational expectations and noisy rational expectations equilibria based on their predictions concerning trading volume around public information signals. Empirical results strongly support the noisy rational expectations hypothesis. This indicates that a significant amount of noise exists (so that private information has value), but not enough to obfuscate entirely the information content of price. Our analysis also indicates that the dispersion of private information across traders has an impact on trading volume, but not on price.