We analyze the welfare implications of information aggregation in a trading model where traders have both idiosyncratic endowment risk and asymmetric information about security payoffs. The optimal market size balances two forces: (i) the risk-sharing role of markets, which creates a positive externality amongst traders, against (ii) the information-aggregation role of prices, which leads to prices that are more correlated with security payoffs, thereby undermining the hedging function of markets. Our analysis indicates that a market with infinitely many traders may not be the right welfare benchmark in the presence of risk aversion and information aggregation.
"Welfare Consequences of Information Aggregation and Optimal Market Size."
American Economic Journal: Microeconomics,
Market Structure, Pricing, and Design: Oligopoly and Other Forms of Market Imperfection
Asymmetric and Private Information; Mechanism Design
Search; Learning; Information and Knowledge; Communication; Belief; Unawareness