Learning Rational Expectations in an Asset Market

Will traders in a risky asset market learn Muthian expectations when they initially lack the necessary information? If some traders learn from their observations, will market dynamics depend only on "fundamentals," as implied by the Efficient Market Hypothesis? This paper shows that at any finite point in time the answer to these questions is "no." The context is a constant absolute risk aversion model with two kinds of traders and asymmetric information. The market converges asymptotically to a rational expectations equilibrium where prices depend only on fundamentals and the market is efficient.