Intrinsic uncertainty and common-knowledge priors in financial economics

This article introduces the concept of intrinsic uncertainty, which occurs in the absence of common knowledge, and its relation to the standard homogeneous beliefs assumption of finance theory. When individuals in an informed environment have homogeneous beliefs (common priors), they objectively agree; however, they can agree without knowing they agree. With homogeneous beliefs, individuals still face intrinsic uncertainty over unknown beliefs of others. If two people have homogeneous beliefs and their informed posteriors for an event E are common knowledge, then–contrary to the widely held view–these posteriors may be unequal. The two people can agree to disagree. Consensus over the probabilities of the possible states requires an agreed common‐knowledge priors assumption.