Dynamic Noisy Rational Expectations Equilibrium With Insider Information

Abstract

We study equilibria in multi‐asset and multi‐agent continuous‐time economies with asymmetric information and bounded rational noise traders. We establish the existence of two equilibria. First, a full communication equilibrium where the informed agents' signal is disclosed to the market and static policies are optimal. Second, a partial communication equilibrium where the signal disclosed is affine in the informed and noise traders' signals, and dynamic policies are optimal. Here, information asymmetry creates demand for two public funds, as well as a dark pool where private information trades can be implemented. Markets are endogenously complete and equilibrium returns have a three factor structure with stochastic factors and loadings. Results are valid for constant absolute risk averse investors, general vector diffusions for fundamentals, nonlinear terminal payoffs, and non‐Gaussian noise trading. Asset price dynamics and public information flows are endogenous, and rational expectations equilibria are special cases of the general results.