Asymmetric Information and Survival in Financial Markets

Abstract

In the evolutionary setting for a financial market developed by Blume and Easley (1992) the author considers an infinitely repeated version of a model B la Grossman and Stiglitz (1980) with asymmetrically informed traders. Informed traders observe the realisation of a payoff relevant signal before making their portfolio decisions. Uninformed traders do not have direct access to this kind of information, but can partially infer it from market prices. As a counterpart to their privileged information, informed traders pay a per period cost. As a result, information acquisition triggers a trade-off in this setting. It is proved that, so long as information is costly, a strictly positive measure of uninformed traders will survive. This result contributes to the literature on noise trading. It suggests that Friedman's (1953) argument is too simplistic. Traders whose beliefs are wrong' according to the best available information, in fact, are not wiped out by market forces and do affect asset prices in the long run.