Abstract
AbstractI analyze a general setting where a policymaker needs information that financial market traders have in order to implement optimal policy, and prices can potentially reveal this information. Policy decisions, in turn, affect asset values. I derive a condition for the existence of fully revealing equilibria in competitive financial markets, which identifies all situations where learning from prices for policy purposes works. I discuss the possibility of using market information for banking supervision and central banking, and the general problem of asset design. I also demonstrate that some corporate prediction markets are ill‐designed, and show how to fix it.
Highlights
I analyze a general setting where a policymaker needs information that financial market traders have in order to implement optimal policy, and prices can potentially reveal this information
I derive a condition for the existence of fully revealing equilibria in competitive financial markets, which identifies all situations where learning from prices for policy purposes works
I discuss the possibility of using market information for banking supervision and central banking, and the general problem of asset design
Summary
I analyze a general setting where a policymaker needs information that financial market traders have in order to implement optimal policy, and prices can potentially reveal this information. I derive a condition for the existence of fully revealing equilibria in competitive financial markets, which identifies all situations where learning from prices for policy purposes works. I discuss the possibility of using market information for banking supervision and central banking, and the general problem of asset design. JEL codes: D53, D82, D84, G10 Keywords: asset design, asymmetric information, financial markets, policy, price informativeness, rational expectations equilibrium, self-defeating prophecy. A central bank (CB) may use asset prices to infer information about inflation expectations or future demand shocks, and adapt policy in response (Bernanke and Woodford 1997). A company could use internal prediction markets—where asset values depend on the launch date of a new product—to predict whether deadlines can be met, and react if forecasts indicate major delays (e.g., Cowgill and Zitzewitz 2015)
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