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Bid-Ask Price Competition with Asymmetric Information between Market-Makers

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  • Riccardo Calcagno
  • Stefano Lovo
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    Abstract

    This paper studies the effect of asymmetric information on the price formation process in a quote-driven market. One market-maker receives private information on the value of the quoted asset and repeatedly competes with market-makers who are uninformed. We show that despite the fact that the informed market-maker's quotes are public, the market is never strong-form efficient with certainty until the last stage. We characterize a reputational equilibrium in which the informed market-maker influences and possibly misleads the uninformed market-makers' beliefs. At this equilibrium, a price leadership effect arises, the informed market-maker's expected pay-off is positive and the rate of price discovery increases in the last stages of trade. Copyright 2006, Wiley-Blackwell.

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    File URL: http://hdl.handle.net/10.1111/j.1467-937X.2006.378_1.x
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    Bibliographic Info

    Article provided by Oxford University Press in its journal The Review of Economic Studies.

    Volume (Year): 73 (2006)
    Issue (Month): 2 ()
    Pages: 329-355

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    Handle: RePEc:oup:restud:v:73:y:2006:i:2:p:329-355

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    Cited by:
    1. Allen, Linda & Gottesman, Aron A. & Peng, Lin, 2012. "The impact of joint participation on liquidity in equity and syndicated bank loan markets," Journal of Financial Intermediation, Elsevier, vol. 21(1), pages 50-78.
    2. Shino Takayama, 2013. "Price Manipulation, Dynamic Informed Trading and Tame Equilibria: Theory and Computation," Discussion Papers Series 492, School of Economics, University of Queensland, Australia.
    3. Schweinzer, Paul, 2010. "Sequential bargaining with common values," Journal of Mathematical Economics, Elsevier, vol. 46(1), pages 109-121, January.
    4. Schweinzer, Paul, 2006. "Sequential bargaining with pure common values," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 137, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.

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