Working Paper: NBER ID: w20516
Authors: Nicolas S. Lambert; Michael Ostrovsky; Mikhail Panov
Abstract: We study trading behavior and the properties of prices in informationally complex markets. Our model is based on the single-period version of the linear-normal framework of Kyle (1985). We allow for essentially arbitrary correlations among the random variables involved in the model: the value of the traded asset, the signals of strategic traders and competitive market makers, and the demand from liquidity traders. We show that there always exists a unique linear equilibrium, characterize it analytically, and illustrate its properties in a series of examples. We then use this characterization to study the informational efficiency of prices as the number of strategic traders becomes large. If liquidity demand is positively correlated (or uncorrelated) with the asset value, then prices in large markets aggregate all available information. If liquidity demand is negatively correlated with the asset value, then prices in large markets aggregate all information except that contained in liquidity demand.
Keywords: No keywords provided
JEL Codes: D53; D82; D84; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity demand positively correlated with asset value (E41) | prices aggregate all available information (P22) |
| liquidity demand uncorrelated with asset value (G19) | prices aggregate all available information (P22) |
| liquidity demand negatively correlated with asset value (E41) | prices aggregate all but that information (P22) |
| liquidity traders' behavior distorts the information aggregation process (D83) | prices aggregate all but that information (P22) |
| increase in the number of strategic traders (C70) | characteristics of liquidity demand influence informational efficiency of prices (G14) |