Working Paper: NBER ID: w18451
Authors: Pierre Collin-Dufresne; Vyacheslav Fos
Abstract: We extend Kyle's (1985) model of insider trading to the case where liquidity provided by noise traders follows a general stochastic process. Even though the level of noise trading volatility is observable, in equilibrium, measured price impact is stochastic. If noise trading volatility is mean-reverting, then the equilibrium price follows a multivariate 'stochastic bridge' process, which displays stochastic volatility. This is because insiders choose to optimally wait to trade more aggressively when noise trading activity is higher. In equilibrium, market makers anticipate this, and adjust prices accordingly. More private information is revealed when volatility is higher. In time series, insiders trade more aggressively, when measured price impact is lower. Therefore, execution costs to uninformed traders can be higher when price impact is lower.
Keywords: No keywords provided
JEL Codes: D4; D8; D80; D82; D83; D84; G0; G00; G1; G10; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| noise trader volatility (C58) | insider trading strategy (G14) |
| insider trading strategy (G14) | price impact (G14) |
| noise trader volatility (C58) | price impact (G14) |
| insider trading strategy (G14) | equilibrium prices (D41) |
| noise trader volatility (C58) | equilibrium prices (D41) |
| price impact (G14) | execution costs for uninformed traders (G14) |