No-trade theorem
Encyclopedia
In financial economics
, the no-trade theorem states that if markets are in a state of efficient
equilibrium
, if there are no noise trader
s or other non-rational interferences with prices, and if the structure by which traders or potential traders acquire information is itself common knowledge, then even though some traders may possess private information, none of them will be in a position to profit from it. The assumptions are deliberately unrealistic, but the theorem may nonetheless be pertinent to debates over inside information
.
It was demonstrated by Paul Milgrom
and Nancy Stokey
in their 1982 paper, "Information, trade and common knowledge".
s even before anyone accepts the bid or offer, so no profit will result. Another way to put it is: all the traders in the market are rational, and thus they know that all the prices are rational/efficient; therefore, anyone who makes an offer to them must have special knowledge - else why would they be making the offer? Accepting the offer would make them a sucker. All the traders will reason the same way, and thus will not accept any offers.
Financial economics
Financial Economics is the branch of economics concerned with "the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment"....
, the no-trade theorem states that if markets are in a state of efficient
Efficiency (economics)
In economics, the term economic efficiency refers to the use of resources so as to maximize the production of goods and services. An economic system is said to be more efficient than another if it can provide more goods and services for society without using more resources...
equilibrium
Economic equilibrium
In economics, economic equilibrium is a state of the world where economic forces are balanced and in the absence of external influences the values of economic variables will not change. It is the point at which quantity demanded and quantity supplied are equal...
, if there are no noise trader
Noise trader
A noise trader also known informally as idiot trader is described in the literature of financial research as a stock trader whose decisions to buy, sell, or hold are irrational and erratic...
s or other non-rational interferences with prices, and if the structure by which traders or potential traders acquire information is itself common knowledge, then even though some traders may possess private information, none of them will be in a position to profit from it. The assumptions are deliberately unrealistic, but the theorem may nonetheless be pertinent to debates over inside information
Inside Information
Inside Information is the sixth studio album by American rock band Foreigner, released in 1987. The album hit #15 on the Billboard 200 Albums Chart and was certified Platinum in the U.S. for sales exceeding one million copies....
.
It was demonstrated by Paul Milgrom
Paul Milgrom
Paul Robert Milgrom is an American economist. He is the Shirley and Leonard Ely Professor of Humanities and Sciences at Stanford University, a position he has held since 1987. Dr. Milgrom is an expert in game theory, specifically auction theory and pricing strategies...
and Nancy Stokey
Nancy Stokey
Nancy Laura Stokey is the Frederick Henry Prince Distinguished Service Professor of Economics at the University of Chicago. She has earned her BA in economics from the University of Pennsylvania in 1972 and her PhD from Harvard University in 1978, her thesis advisor being Nobel Prize in Economics...
in their 1982 paper, "Information, trade and common knowledge".
Informal explanation
Informally put, the idea behind the proof of the no-trade theorem is that if there is common knowledge about the structure of a market, then any bid or offer (i.e. attempt to initiate a trade) will reveal the bidder's private knowledge and will be incorporated into market priceMarket price
In economics, market price is the economic price for which a good or service is offered in the marketplace. It is of interest mainly in the study of microeconomics...
s even before anyone accepts the bid or offer, so no profit will result. Another way to put it is: all the traders in the market are rational, and thus they know that all the prices are rational/efficient; therefore, anyone who makes an offer to them must have special knowledge - else why would they be making the offer? Accepting the offer would make them a sucker. All the traders will reason the same way, and thus will not accept any offers.