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Ch. 1 shows the reader how to model asymmetric information and knowledge in theoretical economics. It also introduces the concept of higher‐order knowledge. For the analysis of bubbles it is important to draw a distinction between mutual knowledge, e.g. all traders know that the price is too high, and common knowledge, i.e. they all know this and that all know and so on. Prices are determined in equilibrium. The two most commonly used equilibrium concepts in market settings with asymmetric information are the competitive Rational Expectations Equilibrium (REE) concept and the strategic Bayesian Nash Equilibrium concept. The chapter compares and contrasts both equilibrium concepts and also highlights their conceptual problems. This chapter also introduces and contrasts the two efficiency concepts: informational efficiency and allocative efficiency.

This chapter examines one line of criticism of the Rational Expectations Hypothesis (REH): expectational coordination failures. It begins by addressing the question of what went wrong with standard economic theory in general and with its modeling principles in particular and offers three answers relating to the diversification of modeling, the rationality hypothesis, and expectational coordination. It then considers the rise of REH in modern economic theory before discussing three avenues of criticism against REH: internal challenges, external criticisms, and criticism based on real-time learning. It also explains how a critical assessment of REH in different contexts changes the standard (REH-based) economic intuition, focusing on the question of the value of new financial instruments; the informational efficiency of the market; and the “good” expectational coordination that Real Business Cycles (RBC)-like models.

This chapter evaluates a long-standing political assumption that the private sector operates more efficiently than the public sector. The chapter argues that the merits of this assumption are highly dubious. At least in regard to informational efficiency, there are few reasons to suspect that the private sector will have a clear advantage over government. The chapter then looks at industries that see both public and private sector involvement, including mail delivery and higher education. Distributional analysis reveals that private sector companies operating in these industries produce outcomes that are characterized by higher levels of instability than those produced by their public counterparts. This suggests that, if anything, the public sector can sometimes process information more efficiently than private firms.

This chapter describes mechanism design without games. The concept of an economics mechanism has many origins. Consequently, there are also different approaches to the study of economic mechanisms. Those using a game-theoretic framework are at present particularly popular, but others focus on informational issues without using the tools of game theory. Some integrate the two approaches. The chapter then defines informational decentralization. It focuses on the privacy preserving property of the response and equilibrium function. The model that the chapter presents gives rise to results of sufficient generality to apply to mechanisms based on game-theoretic principles that take incentives into account as well as those that do not. The results provide upper bounds (sometimes maxima) for informational efficiency (lower bounds for message space size or other measures).

This chapter considers the rationale for, and scope and content of, mandatory disclosure obligations placed on firms issuing securities in capital markets. The explicit regulatory objective of issuer mandatory disclosure for primary as well as secondary markets is investor protection. This chapter aims to reconcile policymakers’ investor protection goal with how market players, including investors, behave in the real world, based on an understanding of the reasons why market forces alone may be insufficient to attain informational efficiency and how they still may put mandated disclosure to good use. Thus, the chapter first asks what the regulatory objectives are for mandating disclosures and how they can be reconciled with economic theory. Next, it answers the question of why mandatory disclosure is needed at all. Then, it provides an overview of disclosure regimes, taking those of the US and the EU as examples. The chapter concludes with a brief discussion of the role of enforcement in ensuring adequate disclosure.

This chapter focuses on the regulation of corporations as “issuers,” that is, as tools to raise finance from the public. All representative “core jurisdictions” have specific rules applying to the offer of securities to the public and to the ongoing governance and disclosure of companies whose securities are held by the investing public. While motivated by the need to protect investors, their economic function is rather in supporting capital markets as an efficient tool to allocate capital among corporations. This requires that markets are informationally efficient and prices are sufficiently informative. After reviewing the reasons why legal rules are held to be necessary to attain of the goal of price informativeness, the chapter examines mandatory disclosure frameworks. It highlights similarities and differences in issuer disclosure rules, assesses the degree of convergence in accounting law, and describes the use of other strategies, including banning insider trading and market manipulation (i.e., securities fraud). Public and private enforcement and gatekeeper control are examined, highlighting the gap in enforcement intensity between the U.S. and other jurisdictions.

Curiously, early neoclassical economics was a theory of agents, not markets as such. But changes in markets in the late twentieth century began to highlight this lacuna. How information was incorporated into the theory began to suggest that economists could not just describe The Market, but could also design boutique markets for clients. We trace the resulting narrative trajectory of this epoch-making departure using an abstract Information Space graphic showing combinations of types of agent epistemology, with different types of models of information.