, Volume 151, Issue 1, pp 119-149
Date: 09 Dec 2006

Incomplete information equilibria: Separation theorems and other myths

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Abstract

The incomplete information financial economic equilibrium (IIE) literature has been growing at an increasing rate since its inception in the early 1980s. This paper examines issues and concepts essential to understanding, implementing, and testing IIE and understanding its relation to complete information equilibria (CIE). Concepts include the number of state variables in an IIE vis-à-vis the number of state variables in a corresponding CIE; the irrelevance of separation theorems to IIE and the relevance, instead, of a more general state space (re-)representation theorem; the identification of unobservable productivity processes that lead to complete information; the relative level of variable variances in a CIE and the corresponding IIE; stochastic CIE with corresponding deterministic IIE and deterministic CIE with corresponding stochastic IIE; the relationship between IIE and incomplete markets; the (im)persistence of heterogeneous beliefs; and the relation of IIE to the model uncertainty/ambiguity approaches. Understanding these concepts under IIE facilitates understanding the CIE, a special case of IIE.