Information Aggregation in Common Value Asset Markets and the Efficient Markets Hypothesis

This paper studies information aggregation in pure common value double auctions with a continuum of traders. This trade environment captures some of the main features of prediction markets. The population includes both sophisticated and näıve traders whose bidding behavior is not influenced by opponents’ equilibrium strategies. Existence and uniqueness of monotone equilibrium prices is shown under mild conditions on the distribution of näıve bids. In these equilibria the mapping from asset values to prices has a domain split into two distinct areas: a revealing region, where prices equal values, and a non-revealing region. If the proportion of näıve traders falls below a (strictly positive) lower bound, prices are perfectly revealing. In contrast, when the presence of näıve traders is above some upper bound prices are almost nowhere revealing. This indicates that, contrary to prevailing views, non-negligible levels of noise or liquidity trade are compatible with perfect information aggregation, although even a moderate presence of boundedly rational traders can lead to nowhere revealing prices. An empirical method to identify the revealing and non-revealing regions is suggested. JEL Classification: C72, D44, D82.