Existence, incentive compatibility and efficiency of the rational expectations equilibrium

The rational expectations equilibrium (REE), as introduced in Radner (1979) in a general equilibrium setting à la Arrow-Debreu-Mckenzie, often fails to have normative properties such as universal existence, incentive compatibility and efficiency. We resolve those problems by providing a new model which makes the standard REE a desirable solution concept. In particular, we consider an asymmetric information economy with a continuum of agents whose private signals are independent conditioned on the macro states of nature; for such an economy, the REE universally exists, is incentive compatible and efficient. Also, we introduce the notion of REE with aggregate signals which extends the standard REE concept by allowing agents to use the information generated by a macroeconomic statistic, namely agents’ aggregate signals. It is shown that this new REE concept also possesses the desirable properties as the standard REE does, but with much more general conditions on agents’ utility functions. ∗Department of Economics, National University of Singapore, 1 Arts Link, Singapore 117570. e-mail: [email protected] †Department of Mathematics, National University of Singapore, 2 Science Drive 2, Singapore 117543. e-mail: [email protected] ‡Department of Economics, University of Illinois at Urbana-Champaign, Champaign, IL 61820. email: [email protected]