8 II. Capital Market Equilibrium With Incomplete Information In this section, we develop a two-period model of capital market equilibrium in an environment where each investor knows only about a subset of the available securities. In subsequent sections, we explore the impact on the structure of equilibrium asset prices caused by this particular type of incomplete information There are n firms in the economy whose end-of-period cash flows are technologically specified by where denotes a random variable common factor with E(Y)=0 E(Y)-1andE()-E(1,2…;-1,+1……,,Y)=0,k=1,…n I denotes the amount of physical investment in firm k and and s, represent parameters of firm k's production technology, Let v, denote the equilibrium value of firm k at the beginning of the period. If is the equilibrium return per dollar from investing in the firm over the period, then 段瓦1++k, (2) where from(1),x-e(r )=Ikk/k,"T and "%Kkk k - l,..., n. By inspection of (2), the structure of returns is like that of the Sharpe (1964)"diagonal"model or the" one-factor version of the Ross (1976) Arbitrage Pricing Theory(APT) model In addition to shares in the firms, there are two other traded-8- II. Capital Market Equilibrium With Incomplete Information In this section, we develop a two-period model of capital market equilibrium in an environment where each investor knows only about a subset of the available securities. In subsequent sections, we explore the impact on the structure of equilibrium asset prices caused by this particular type of incomplete information. There are n firms in the economy whose end-of-period cash flows are technologically specified by: ik -LIk Elk y +k (1) where Y denotes a random variable common factor with E(Y) = 0 and E(r) = 1 and E(Ek) = E(Ek l 1 C ,... 2 ,+ , l ,.. , n Y) = O , k =n. Ik denotes the amount of physical investment in firm k and 1 k' ak and sk represent parameters of firm k's production technology. Let Vk denote the equilibrium value of firm k at the beginning of the period. If Rk is the equilibrium return per dollar from investing in the firm over the period, then Rk = Ck/Vk, and % - % % R = + bkY + ki (2) R 2=R~+b~a , (2) where from (1), R = E(Rk) = Ikpk/Vk; bk = akk/Vk and = SkIk/Vk k = l,...,n. By inspection of (2), the structure of returns is like that of the Sharpe (1964) "diagonal" model or the "one-factor" version of the Ross (1976) Arbitrage Pricing Theory (APT) model. In addition to shares in the firms, there are two other traded