Differential Beliefs in Financial Markets Under Information Constraints: A Modeling Perspective

Abstract

We apply the theory of McKean-Vlasov-type SDEs to study several problems related to market efficiency in the context of partial information and partially observable financial markets: (i) convergence of reduced-information market price processes to the true price process under an increasing information flow; (ii) a specific mechanism of shrinking biases under increasing information flows; (iii) optimal aggregation of expert opinions by a trader seeking a positive alpha. All these problems are studied by means of (conditional) McKean-Vlasov-type SDEs, Wasserstein barycenters, KL divergence and relevant tools from convex optimization, optimal control and nonlinear filtering. We supply the theoretical results in (i)-(iii) with concrete simulations demonstrating how the proposed models can be applied in practice to model financial markets under information constraints and the arbitrage-seeking behavior of traders with differential beliefs.