The authors examine why perfectly informationally efficient markets cannot exist when acquiring information is costly. Their model shows that prices must remain somewhat imperfect so informed traders can be compensated, with market informativeness shaped by information costs, noise, risk aversion, and information quality.
On the Impossibility of Informationally Efficient Markets
Joseph Stiglitz, Sanford Grossman
Research
16 Pages
Key Takeaways
Efficiency Has Limits: With 0 noise, prices reveal all information, eliminating incentives to acquire it and preventing a competitive equilibrium from existing.
Information Creates Balance: The model’s interior equilibrium requires the informed share of traders to remain between 0 and 1, allowing prices to convey information imperfectly.
Seven Core Conjectures: The authors develop 7 conjectures showing how information costs, noise, and information quality influence market informativeness and the proportion of informed traders.
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