Liquidity and asset prices in rational expectations equilibrium with ambiguous information

Han Ozsoylev, Jan Werner

Research output: Contribution to journalArticlepeer-review

50 Scopus citations


The quality of information in financial asset markets is often hard to estimate. Reminiscent of the famous Ellsberg paradox, investors may be unable to form a single probability belief about asset returns conditional on information signals and may act on the basis of ambiguous (or multiple) probability beliefs. This paper analyzes information transmission in asset markets when agents' information is ambiguous. We consider a market with risk-averse informed investors, risk-neutral competitive arbitrageurs, and noisy supply of the risky asset, first studied by Vives (Rev Financ Stud 8:3-40, 1995a, J Econ Theory 67:178-204, 1995b) with unambiguous information. Ambiguous information gives rise to the possibility of illiquid market where arbitrageurs choose not to trade in a rational expectations equilibrium. When market is illiquid, small informational or supply shocks have relatively large effects on asset prices.

Original languageEnglish (US)
Pages (from-to)469-491
Number of pages23
JournalEconomic Theory
Issue number2
StatePublished - Oct 1 2011


  • Ambiguity
  • Asymmetric information
  • Liquidity
  • Rational expectations equilibrium


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