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Imperfect Competition and Market Liquidity with a Supply Informed Trader

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Abstract

We develop a model of insider trading where agents have private information either about liquidation value or about supply and behave strategically to maximize their profits. The supply informed trader plays a dual role in market making and in information revelation. This trader not only reveals a part of the information he owns, but he also induces the other traders to reveal more of their private information. The presence of different types of information decreases market liquidity and induces non-monotonicity of the market indicators with respect to the variance of liquidation value. Replacing the noise introduced by liquidity traders with a random supply also allows us to study the effect the shocks on different components of supply have on prices and quantities.

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Paper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 591.03.

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Length: 44
Date of creation: 08 Oct 2003
Date of revision:
Handle: RePEc:aub:autbar:591.03

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Keywords: insider trading; imperfect competition; market liquidity;

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  1. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
  2. Frederic Palomino, 2001. "Informational efficiency: ranking markets," Economic Theory, Springer, vol. 18(3), pages 683-700.
  3. Caballe, Jordi & Krishnan, Murugappa, 1994. "Imperfect Competition in a Multi-security Market with Risk Neutrality," Econometrica, Econometric Society, vol. 62(3), pages 695-704, May.
  4. Brown, David P & Zhang, Zhi Ming, 1997. " Market Orders and Market Efficiency," Journal of Finance, American Finance Association, vol. 52(1), pages 277-308, March.
  5. Rochet, Jean-Charles & Vila, Jean-Luc, 1994. "Insider Trading without Normality," Review of Economic Studies, Wiley Blackwell, vol. 61(1), pages 131-52, January.
  6. 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.
  7. Ananth N. Madhavan, . "Trading Mechanisms in Securities Markets," Rodney L. White Center for Financial Research Working Papers 16-90, Wharton School Rodney L. White Center for Financial Research.
  8. Kyle, Albert S, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Wiley Blackwell, vol. 56(3), pages 317-55, July.
  9. Katrina Ellis & Roni Michaely & Maureen O'Hara, 2002. "The Making of a Dealer Market: From Entry to Equilibrium in the Trading of Nasdaq Stocks," Journal of Finance, American Finance Association, vol. 57(5), pages 2289-2316, October.
  10. Holden, Craig W & Subrahmanyam, Avanidhar, 1992. " Long-Lived Private Information and Imperfect Competition," Journal of Finance, American Finance Association, vol. 47(1), pages 247-70, March.
  11. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  12. Gerard Gennotte and Hayne Leland., 1989. "Market Liquidity, Hedging and Crashes," Research Program in Finance Working Papers RPF-184, University of California at Berkeley.
  13. Bhattacharya, Utpal & Spiegel, Matthew, 1991. "Insiders, Outsiders, and Market Breakdowns," Review of Financial Studies, Society for Financial Studies, vol. 4(2), pages 255-82.
  14. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1990. "Herd on the Street: Informational Inefficiencies in a Market with Short-Term Speculation," NBER Working Papers 3250, National Bureau of Economic Research, Inc.
  15. Jackson, Matthew O, 1991. "Equilibrium, Price Formation, and the Value of Private Information," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 1-16.
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