Market Created Risk

  • Author(s): ALAN KRAUS, MAXWELL SMITH
  • Published: Apr 30, 2012
  • Pages: 557-569
  • DOI: 10.1111/j.1540-6261.1989.tb04378.x

ABSTRACT

We develop a multiperiod rational expectations model of securities market equilibrium in which equilibrium prices may move between periods even though it is common knowledge that no new information has arrived about ultimate security payoffs. This happens because investors know they have imperfect information about the endowments of other investors and this knowledge affects their probability beliefs about the prices that will prevail at the intermediate trading date. These beliefs are reflected in the equilibrium at the initial trading date when investors focus on the probabilities of intermediate capital gains and losses, rather than ultimate payoffs.

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