A Battle of Price Manipulators and the Market Game Foundations for Rational Expectations Equilibrium∗

Manipulation of prices and convergence to rational expectations equilibrium is studied in a game without noise traders. Informed players with initially long and short positions (bulls and bears) seek to manipulate consumer expectations in opposite directions. In equilibrium, bears and uninformed consumers sell up to their short-sale limits in period 1. Bulls buy in period 1 but receive arbitrage losses. When the number of bulls and bears approaches infinity, the equilibrium converges to the REE. Without shortsale constraints we have an unstable situation, with bulls and bears each seeking to out-leverage the other, with no revealing equilibrium possible. ∗This paper developed out of a research project with Rich McLean and Andy Postlewaite, to whom I am extremely grateful. I bear sole responsibility for mistakes, however.