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Informational efficiency and welfare
Luca Bernardinelli1, Paolo Guasoni2,3, Eberhard Mayerhofer4
1London, UK.
Mathematics and Financial Economics
|September 27, 2022
Summary
In financial markets, accurate information improves efficiency but lowers agent consumption. This study shows that while precise economic state estimates are achieved, the price of risk decreases, impacting welfare.
Area of Science:
- Financial economics
- Market microstructure
- Information economics
Background:
- Continuous-time financial markets involve agents making consumption and investment decisions.
- Agents use public information (prices, dividends) and private signals.
- Economic states influence asset dividend streams.
Purpose of the Study:
- To analyze the impact of private information on market equilibrium and agent welfare.
- To investigate the relationship between informational efficiency and market volatility.
- To understand how risk aversion affects consumption and investment decisions.
Main Methods:
- Developed a continuous-time market model with heterogeneous agents.
- Incorporated private signals and latent economic states.
- Analyzed equilibrium price formation and agent behavior under constant absolute risk aversion.
Main Results:
- Equilibrium prices aggregate private signals efficiently, leading to accurate state estimates.
- Increased informational accuracy reduces market volatility and enhances apparent market efficiency.
- However, this efficiency comes at the cost of reduced agent consumption due to a lower price of risk.
Conclusions:
- Informational efficiency in financial markets can be achieved at the expense of agent welfare.
- The trade-off between market efficiency and individual consumption is a critical consideration.
- Policy or market design should account for this welfare implication of information aggregation.
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