Theories of speculation and the economics of information

This dissertation studies informational asymmetries and explores some new areas of uncertainty in economic decision-making. The first chapter contains a statement of the main contributions of each chapter and a literature review on speculation theory, informational content of prices, and speculative bubbles. Chapter 2 discusses intrinsic uncertainty and higher-order beliefs. The chapter's main theme is that individuals can agree without knowing they agree and that agreed common knowledge priors can eliminate this intrinsic uncertainty. Chapter 2 introduces a new framework for common knowledge beliefs and two propositions that clarify the very fundamental assumptions that guarantee equilibrium consensus.

Chapter 3 examines the impact of intrinsic uncertainty on the major asset pricing paradigms. Since intrinsic uncertainty has been a neglected research topic in mathematical economics and financial economics, it is not surprising to find the Modigliani-Miller paradigm, Arbitrage Pricing Theory, and Option Pricing Theory depend on common knowledge beliefs assumptions. The Capital Asset Pricing Model subsumes common knowledge through assumptions about perfect information about the returns to assets.

Whereas Chapter 3 illustrates speculation based on intrinsic uncertainty, Chapter 4 illustrates speculation with agreed common knowledge priors but with a known dichotomy between informed and uninformed traders. Rather than attempting to iterate to consensus as in Chapter 2, the traders in Chapter 4 buy and sell assets and draw iv inferences from the behavior of others. Chapter 4 presents a Bayesian Nash equilibrium of speculative bubbles and emphasizes the feedback effect stemming from informed trader purchases. This chapter presents the first game theoretic analysis of speculative bubbles as well as the first fully rational, payoff-maximizing approach to bubble formation.