Case Objective

To understand market efficiency information revelation through prices when asset payoffs are correlated.

 

Key Concepts

Market efficiency; rational expectations.

 

Case description

There are three stocks, traded over two periods.  The values of the stocks at the end of the second period depend on whether the firms win some lucrative contracts.   The interest rate each period is set at 0%, so the time value of money plays no role in this case.  You can borrow at this rate and also short sell the stocks. 

 

In each period, a firm can win or not win contracts.  Winning all the contracts is the best event, while not winning anything is the worst event.  Firms 2 and 3 compete for the same contract, so a good event for one is bad for the other.  Firm 1 competes in a separate market.  The events determine the dividends paid by the firms at the end of period 1 and also the value of the firm at the end of period 2. You may receive information about these events.  Prices in this case are determined by the traders.

 

Case Data

The next table describes the events and shows the dividends paid by each firm at the end of period 1 depending on the period 1 event.