Speculative trading under lack of common knowledge

What is it about?

A lack of common knowledge can easily destabilize prices in speculative trading. We generalize a standard rational expectations equilibrium model with different information by allowing differences in higher-order beliefs. Bubbles can arise when investors have inconsistent higher-order beliefs that their own expectations are more optimistic than average.

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Why is it important?

We construct an analytically tractable equilibrium which can be used to simplify discussion of otherwise difficult issues concerning higher-order beliefs. The model nests conveniently into a standard rational expectations framework which assumes all parameters describing the economic environment are common knowledge.

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