Market efficiency and inefficiency in rational expectations equilibria

Abstract

The paper examines time series properties and efficiency of a securities market where disparately informed traders hold rational expectations and extract signals from the endogenous market price. Two equilibria are calculated, using a method of Sargent to handle the problem of infinite regress. When rational speculation is the sole source of potential trade, the market price reflects all private information, and zero trade occurs. When net supply is perturbed by unobserved noise, the market exhibits a broad range of characteristics cited in empirical literature, including excess volatility, mean reversion, dividend yield effects, trading volume, and divergence of opinion.

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