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Market Microstructure Invariance: A Dynamic Equilibrium Model

Author

Listed:
  • Albert S. Kyle

    (University of Maryland)

  • Anna A. Obizhaeva

    (New Economic School)

Abstract

We derive invariance relationships in a dynamic, infinite-horizon, equilibrium model of adverse selection with risk-neutral informed traders, noise traders, market makers, and with endogenous information production. Scaling laws for bet size and transaction costs require the assumption that the effort required to generate one bet does not vary across securities and time. Scaling laws for pricing accuracy and market resiliency require the additional assumption that private information has the same signal-to-noise ratio across markets. Prices follow a martingale with endogenously derived stochastic volatility. Returns volatility, pricing accuracy, liquidity, and market resiliency are connected by a specific proportionality relationship. The model solution depends on two state variables: stock price and hard-to-observe pricing accuracy. Invariance makes predictions operational by expressing them in terms of log-linear functions of easily observable variables such as price, volume, and volatility.

Suggested Citation

  • Albert S. Kyle & Anna A. Obizhaeva, 2020. "Market Microstructure Invariance: A Dynamic Equilibrium Model," Working Papers w0267, New Economic School (NES).
    • Handle: RePEc:abo:neswpt:w0267
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    File URL: https://www.nes.ru/files/Preprints-resh/WP267.pdf
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    References listed on IDEAS

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    4. LeRoy, Stephen F, 1989. "Efficient Capital Markets and Martingales," Journal of Economic Literature, American Economic Association, vol. 27(4), pages 1583-1621, December.
    5. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    6. Kerry Back & Shmuel Baruch, 2004. "Information in Securities Markets: Kyle Meets Glosten and Milgrom," Econometrica, Econometric Society, vol. 72(2), pages 433-465, March.
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