Econometrica: Jul, 1981, Volume 49, Issue 4

Rational Expectations, Information Acquisition, and Competitive Bidding

https://doi.org/0012-9682(198107)49:4<921:REIAAC>2.0.CO;2-W
p. 921-943

Paul R. Milgrom

Most rational expectations market equilibrium models are not models of price formation, and naive mechanisms leading to such equilibria can be severely manipulable. In this paper, a bidding model is developed which has the market-like features that bidders act as price takers and that prices convey information. Higher equilibrium prices convey more favorable information about the quality of the objects being sold than do lower prices. Bidders can benefit from trading only if they have a transactions motive or if they have access to inside information. Apart from exceptional cases, prices are not fully revealing. A two stage model is developed in which bidders may acquire information at a cost before bidding and for which the equilibrium price is fully revealing, resolving a well-known paradox.