Net trade and market efficiency in Grossman and Stiglitz (1980)

In this paper, we correct part (b) of Theorem 6 of Grossman and Stiglitz (GS, 1980). We demonstrate that when the private signal tends to be perfect, the market converges to strong-form efficiency, and thus informed and uninformed traders have almost homogeneous beliefs about the stock payoff, but there is still significant net trade, rather than no trade as erroneously shown by GS. We further show that when the stock price becomes more informative, and thus traders’ beliefs about the stock payoff become closer, the net trade may increase. JEL Classification: G10; G12, G14