The concepts introduced in the previous chapter allow us to derive some results in a fairly general setting. In this chapter we demonstrate the general properties of equilibrium trades and asset prices. Before analyzing asset prices, we will first focus on equilibrium trades and trading volume in an asymmetric information setting. Section 2.1 illustrates different no-trade theorems and no-speculation theorems.
Sections 2.2 and 2.3 are concerned with the pricing of assets. Section 2.2 introduces the basics of standard competitive asset pricing under symmetric information and highlights the complications that arise if traders are asymmetrically informed. Information revelation by prices is closely linked to the security structure and market completeness. We will distinguish between dynamically complete markets and completely equitizable markets in multiperiod models with asymmetric information.
Dynamic asset pricing leads us to the analysis of bubbles. Bubbles that are common knowledge, like in a symmetric information setting, arise only under special circumstances. In contrast, in settings where market participants are asymmetrically informed, bubbles are typically not common knowledge. Necessary conditions for the existence of bubbles are derived in settings with higher-order uncertainty. Higher-order uncertainty and higher knowledge concepts were introduced in Section 1.1.
An immense number of transactions occur in financial markets. The large trading volume in the foreign exchange market is one illustrative example. Currency trading in foreign exchange markets amounts to more than ten times the value of imported and exported goods. One might think that this high trading volume cannot be explained without