Consider an exchange economy with asymmetric information. What is the set of outcomes that are consistent with common knowledge of rationality and market clearing?To address this question we define an epistemic model for the economy that provides a complete description not only of the beliefs of each agent on the relationship between states of nature and prices but also of the whole system of interactive beliefs. The main result, Theorem 1, provides a characterization of outcomes that are consistent with common knowledge of rationality and market clearing (henceforth, CKRMC outcomes) in terms of a solution notion - Ex-Post Rationalizability - that is defined directly in terms of the parameters that define the economy. CKRMC manifests several intuitive properties that stand in contrast to the full revelation property of Rational Expectations Equilibrium. In particular, for a robust class of economies: (1) there is a continuum of prices that are consistent with CKRMC in every state of nature, and hence these prices do not reveal the true state, (2) the range of CKRMC outcomes is monotonically decreasing as agents become more informed about the economic fundamentals, and (3) trade is consistent with common knowledge of rationality and market clearing even when there is common knowledge that there are no mutual gains from trade.
Bibliographical noteFunding Information:
This is a major revision of the working paper “Rationalizable Expectations.” We thank the Israel Science Foundation for grant No. 901/02 that supported this research. Research for this paper was conducted while the first author was a member at the Institute of Avanced Study in Princeton. The hospitality of the Institute is gratefully acknowledged. The first author also acknowledges the support of the Shonbrunn Chair in Mathematical Economics . We are grateful for comments of seminar participants at the Institute for Advanced Study, Cambridge, Columbia, The Hebrew University, LSE, NYU, Penn, Princeton, Rutgers, Stanford, Yale, and Tel Aviv. We are especially grateful for the comments of the associate editor and two referees.
- Asymmetric information
- Common knowledge
- Exchange economy
- Rational expectations