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Strategic Behavior and Price Discovery

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  • Medrano, Luis Angel
  • Vives, Xavier

Abstract

We analyze the effects of strategic behavior by a large informed trader in a price discovery process used in opening auctions in continuous trading systems. It is found that the large informed trader manipulates the market using a contrarian strategy to neutralize the effect of the trades of competitive informed agents. Furthermore, consistent with the empirical evidence available, we find that information revelation accelerates close to the opening, that the market price approaches but does not converge to the fundamental value, and that the expected trading volume displays a U-shaped pattern. Copyright 2001 by the RAND Corporation.

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Bibliographic Info

Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 32 (2001)
Issue (Month): 2 (Summer)
Pages: 221-48

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Handle: RePEc:rje:randje:v:32:y:2001:i:2:p:221-48

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  1. Jarrow, Robert A., 1992. "Market Manipulation, Bubbles, Corners, and Short Squeezes," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 27(03), pages 311-336, September.
  2. Rochet, J.C. & Vila, J.L., 1993. "Insider Trading Without Normality," Papers, Toulouse - GREMAQ 93.b, Toulouse - GREMAQ.
  3. Foster, F. Douglas & Viswanathan, S., 1994. "Strategic Trading with Asymmetrically Informed Traders and Long-Lived Information," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 29(04), pages 499-518, December.
  4. Kumar, Praveen & Seppi, Duane J, 1992. " Futures Manipulation with "Cash Settlement."," Journal of Finance, American Finance Association, American Finance Association, vol. 47(4), pages 1485-502, September.
  5. Holden, Craig W. & Subrahmanyam, Avanidhar, 1994. "Risk aversion, imperfect competition, and long-lived information," Economics Letters, Elsevier, Elsevier, vol. 44(1-2), pages 181-190.
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  7. Laffont, Jean-Jacques & Maskin, Eric S, 1990. "The Efficient Market Hypothesis and Insider Trading on the Stock Market," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 98(1), pages 70-93, February.
  8. Colin F. Camerer, 1998. "Can Asset Markets Be Manipulated? A Field Experiment with Racetrack Betting," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 106(3), pages 457-482, June.
  9. Gould, John P & Verrecchia, Robert E, 1985. "The Information Content of Specialist Pricing," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 93(1), pages 66-83, February.
  10. Benabou, R. & Laroque, G., 1989. "Using Privileged Information To Manipulate Markets: Insiders, Gurus, And Credibility," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 513, Massachusetts Institute of Technology (MIT), Department of Economics.
  11. Keim, Donald B. & Madhavan, Ananth, 1995. "Anatomy of the trading process Empirical evidence on the behavior of institutional traders," Journal of Financial Economics, Elsevier, Elsevier, vol. 37(3), pages 371-398, March.
  12. Colin Camerer, 1998. "Can asset markets be manipulated? A field experiment with racetrack betting," Natural Field Experiments, The Field Experiments Website 00222, The Field Experiments Website.
  13. Jordan, J. S., 1985. "Learning rational expectations: The finite state case," Journal of Economic Theory, Elsevier, Elsevier, vol. 36(2), pages 257-276, August.
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  15. Hart, Oliver D, 1977. "On the Profitability of Speculation," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 91(4), pages 579-97, November.
  16. Back, Kerry, 1992. "Insider Trading in Continuous Time," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 5(3), pages 387-409.
  17. Fishman, Michael J & Hagerty, Kathleen M, 1995. "The Mandatory Disclosure of Trades and Market Liquidity," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 8(3), pages 637-76.
  18. Charles Cao & Eric Ghysels & Frank Hatheway, 1998. "Why Is the Bid Price Greater than the Ask? Price Discovery during the Nasdaq Pre-Opening," CIRANO Working Papers, CIRANO 98s-14, CIRANO.
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Cited by:
  1. Werner Stanzl & Gur Huberman, 2000. "Arbitrage-Free Price-Update and Price-Impact Functions," Yale School of Management Working Papers, Yale School of Management ysm164, Yale School of Management, revised 01 Jan 2001.
  2. Sandro Brusco & Carolina Manzano & Mikel Tapia, 2003. "Price Discovery In The Pre-Opening Period. Theory And Evidence From The Madrid Stock Exchange," Business Economics Working Papers, Universidad Carlos III, Departamento de Economía de la Empresa wb035814, Universidad Carlos III, Departamento de Economía de la Empresa.
  3. Ryan Davies, 2000. "Registered trader participation during the Toronto Stock Exchange's pre-opening session," Working Papers, Queen's University, Department of Economics 997, Queen's University, Department of Economics.
  4. Barclay, Michael J. & Hendershott, Terrence, 2008. "A comparison of trading and non-trading mechanisms for price discovery," Journal of Empirical Finance, Elsevier, Elsevier, vol. 15(5), pages 839-849, December.
  5. Biais, Bruno & Glosten, Larry & Spatt, Chester, 2005. "Market microstructure: A survey of microfoundations, empirical results, and policy implications," Journal of Financial Markets, Elsevier, Elsevier, vol. 8(2), pages 217-264, May.
  6. Comerton-Forde, Carole & Rydge, James, 2006. "The influence of call auction algorithm rules on market efficiency," Journal of Financial Markets, Elsevier, Elsevier, vol. 9(2), pages 199-222, May.
  7. Davies, Ryan J., 2003. "The Toronto Stock Exchange preopening session," Journal of Financial Markets, Elsevier, Elsevier, vol. 6(4), pages 491-516, August.

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