A battle of informed traders and the market game foundations for rational expectations equilibrium

•We model price manipulation where bulls and bears seek to manipulate the price in opposite directions.•A fully revealing equilibrium is constructed, which converges to the fully revealing REE under replication.•Without short-sale restrictions there is no revealing equilibrium, but there is a non-revealing equilibrium.

Potential manipulation of prices and convergence to rational expectations equilibrium is studied in a game without noise traders. Informed players with initially long and short positions (bulls and bears) seek to manipulate consumer expectations in opposite directions. In equilibrium, period 1 prices reveal the state, so manipulation is unsuccessful. Bears and uninformed consumers sell up to their short-sale limits in period 1. Bulls buy in period 1 but receive arbitrage losses. When the number of bulls and bears approaches infinity, the equilibrium converges to the REE. Without short-sale constraints there is a non-revealing equilibrium but no revealing equilibrium.