Finance - Theses
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ItemEssays on Perfect Foresight in Asset Pricing( 2020)Through experimental and theoretical analysis, this thesis addresses the question of how the context of information in capital markets can affect the occurrence of perfect foresight equilibria. It contains three essays that build on theoretical and experimental applications of the perfect foresight assumption. The first essay contrasts theoretical and experimental strains of information aggregation – the ability of prices to aggregate disparate pieces. It contains a methodological guide for designing robust information aggregation experiments with a detailed description of the pilot studies that were used to develop the experimental study in the second essay. The second essay introduces two new theoretical concepts to the analysis of rational expectations equilibrium models. These concepts stem from “stability” characteristics inherent to the perfect foresight state-price mapping. Differences in stability characteristics are shown to arise from differences in the initial information structure underlying the aggregation problems. In the experiment, we test information aggregation with two fundamental information structures in continuous time double auction asset markets: The first information structure is motivated by the canonical information aggregation model in theoretical asset pricing. In this setting, the asset traded pays according to the average privately held information signal in the market. This setting has a stable state-price mapping and is shown to aggregate information well. The second information structure is motivated by prediction markets and studies in experimental finance. Both feature winner-take-all contracts where binary pay depends on the signal type held by the majority of agents. This setting is unstable under the theoretical stability concepts and is shown to aggregate information less efficiently. The third essay examines the use of perfect foresight when modelling disagreement in financial markets. In particular, we examine the conditions under which the perfect foresight approach can be used in a rational expectations equilibrium model. We show that an agent’s perfect foresight may be inconsistent with their own beliefs (based on subjective probabilities) unless their higher-order beliefs (about other participants’ beliefs) are correct.