JIANG WANG INTERTEMPORAL ASSET PRICES 251 holdings not only depend on the value of underlying state variables but also depend on the reaction of uninformed investors.Informed investors take advantage of the errors made by less-informed investors to make profits.The uninformed investors trade based on information extracted from prices and dividends.We find that in some cases,the uninformed investors rationally adopt trading strategies that look like trend chasing:they buy stocks when prices go up and sell when prices go down.A number of studies present evidence consistent with this type of trend-chasing strategy.3 Our results show that trend-chasing-like behaviour can be rational for less-informed investors under asymmetric information while informed investors behave as contrarians. There are two major obstacles in tackling the problem of dynamic asset pricing under asymmetric information.One is the notion of "no trading"and/or "fully revealing" (Grossman (1981),and Milgrom and Stokey (1985))and the other is the mathematical difficulty involved in deriving the equilibrium.The"no-trading theorem"states that if asymmetric information is the only motivation for trading,then an investor reveals his information to the market by his willingness to trade.Hence,information asymmetry is eliminated in equilibrium and no trade actually occurs as new information comes in. This result crucially depends on the market structure of the economy(see,e.g.,Grossman (1977,1981)).Under incomplete markets,there can be motivations other than the arrival of new information that cause investors to trade.In this case,the argument for the irrelevance of heterogeneous information breaks down.When information asymmetry is coupled with an incomplete market structure,the problem becomes mathematically involved.The current model,to our knowledge,is the first dynamic asset pricing model under asymmetric information which provides a closed-form solution. We organize the paper as follows.The formal model is spelled out in Section 2.In Section 3,we consider the simple situation in which investors have homogeneous and perfect information about the economy.This provides a benchmark case for our economy. A rational expectations equilibrium of the full model is obtained in Section 4 by sequen- tially solving the problems of investors'rational learning,optimization and market equilibrium.In Section 5,we investigate how the underlying information structure of the economy,especially information asymmetry,affects risk premia,price volatility and serial correlation in returns.In Section 6,we analyze the optimal investment strategies of investors with different information.Some further comments are provided in Section 7.Section 8 concludes. 2.THE ECONOMY We consider a simple economy with a single physical good.The economy is defined as follows. Assumption 1.The economy is endowed with a certain amount of risky equity. Each unit of the risky equity generates a flow of output(dividend)at an instantaneous 5.See,Anderassen and Kraus (1988),Case and Shiller (1988),Frenkel and Froot (1988)and Shiller (1987).See also Soros (1987). 6.See Duffie and Huang(1986)and He and Pearson(1988). 7.The information structure in this paper is similar to the one considered by Townsend (1981).Singleton (1985),Carino(1986)considered models in which all private information becomes public after a short period (one or two periods)so that effectively the less-informed investors'learning problem becomes a static one.In this paper,we allow private information to remain private.Therefore,the less-informed investors'learning problem becomes dynamic which generates interesting results concerning their optimal investment strategies and equilibrium prices