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Information aggregation in a noisy rational expectations economy

Douglas W. Diamond; Robert E. Verrecchia
Journal of Financial Economics 1981 9(3), 221-235
This paper analyzes a general equilibrium model of a competitive security market in which traders possess independent pieces of information about the return of a risky asset. Each trader conditions his estimate of the return both on his own private source of information and price, which in equilibrium serves as a ‘noisy’ aggregator of the total information observed by all traders. A closed-form characterization of the rational expectations equilibrium is presented. A counter-example to the existence of ‘fully revealing’ equilibrium is developed.