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Insider Trading With Temporary Price Impact

Author

Listed:
  • WESTON BARGER

    (Department of Applied Mathematics, University of Washington, Seattle, Washington 98195, USA)

  • RYAN DONNELLY

    (Department of Mathematics, King’s College London, Strand, London, WC2R 2LS, UK)

Abstract

We model an informed agent with information about the future value of an asset trying to maximize profits when the agent’s trades are subjected to a transaction cost as well as a market maker tasked with setting fair transaction prices. In a single auction model, equilibrium is characterized by the unique root of a particular polynomial. Analysis of this polynomial with small levels of risk-aversion and transaction costs reveal a dimensionless parameter which captures several orders of asymptotic accuracy of the equilibrium behavior. In a continuous time analogue of the single auction model, incorporation of a transaction costs allows the informed agent’s optimal trading strategy to be obtained in feedback form. Linear equilibrium is characterized by the unique solution to a system of two ordinary differential equations, of which one is forward in time and one is backward. When transaction costs are in effect, the price set by the market maker in equilibrium is not fully revealing of the informed agent’s private signal, leaving an information gap at the end of the trading interval. When considering vanishing transaction costs, the equilibrium trading strategy and pricing rules converge to their frictionless counterparts.

Suggested Citation

  • Weston Barger & Ryan Donnelly, 2021. "Insider Trading With Temporary Price Impact," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 24(02), pages 1-32, March.
    • Handle: RePEc:wsi:ijtafx:v:24:y:2021:i:02:n:s0219024921500060
    DOI: 10.1142/S0219024921500060
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    Cited by:

    1. Reda Chhaibi & Ibrahim Ekren & Eunjung Noh & Lu Vy, 2022. "A unified approach to informed trading via Monge-Kantorovich duality," Papers 2210.17384, arXiv.org.
    2. Ibrahim Ekren & Brad Mostowski & Gordan v{Z}itkovi'c, 2022. "Kyle's Model with Stochastic Liquidity," Papers 2204.11069, arXiv.org.

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