Financial markets with asymmetric information: An expository review of seminal models

Abstract

The purpose of this paper is to make an expository review of the seminal models of the rational expectations equilibrium models in the finance literature. The staggering explosion of the complex research in this area of the finance literature has come to existence when the perfect market assumption of homogeneous information is relaxed and prices play the role of aggregating and transmitting information in the financial market. This expository review, therefore, brings out: (1) the seminal models (i.e., the models with a contribution to theory, rather than application of an existing theory); (2) the essential structure and theoretical contribution of each model in relation to the other models; and (3) the informational role of prices (i.e., fully-revealing versus partially-revealing nature of the models). This paper systematically brings out the seminal rational expectations equilibrium models in the following three categories. The first category being comprised of the pioneer models, Grossman (1976) and Grossman and Stiglitz (1980). The second category being composed of the price-taking competitive models, a direction initiated by Hellwig (1980). The third category including the non-price-taking non-competitive models, a direction initiated by Kyle (1984, 1985).