Asset pricing under asymmetric information

This article investigates the impacts of asymmetric information with a Lucas asset pricing economy. Asymmetry enters via the assumption that one group of agents is equipped with superior information about the dividend process. The agents maximize their lifetime utility of the underlying consumption process obtained from the agents' budget contraints, where the agents have the opportunity to invest in a risky asset to transfer income from the current to future periods. Since a closed form solution for the market price cannot be derived analytically, projection methods are applied, as described in Judd, to approximate the expectation integrals in the agents' Euler equations. We derive the result that the informed trader only clearly improves his situation as compared to the non-trade situation if the uninformed trader only observes his own endowment but not the endowment of the informed trader. In the case where agents observe each others' endowment trade never results in a Pareto improvement.