Asymmetric Information and Survival in Financial Markets

In the evolutionary setting for a …nancial market developed by Blume and Easley (1992), we consider an in…nitely repeated version of a model à la Grossman and Stiglitz (1980) with asymmetrically informed traders. Informed traders observe the realisation of a payo¤ 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 for their privileged information, informed traders pay a per period cost. As a result, information acquisition triggers a trade-o¤ in our setting. We prove that, as 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 (1953)’s argument against the importance of noise traders in the process of price determination 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 a¤ect asset prices in the long run. JEL Classi…cation: D50, D82, G14.