Equilibrium, Price Formation, and the Value of Private Information

Abstract

An economy is analyzed in which agents first choose whether to acquire costly information about the return to a risky asset, and then choose demand functions that determine the allocation of assets. It is a well-known paradox that if agents are price-takers and prices are fully revealing, then an equilibrium with costly information acquisition does not exist. It is shown that if the price formation process is modeled explicitly and agents are not price-takers, then it is possible to have an equilibrium with fully revealing prices and costly information acquisition.