Expectations, Liquidity, and Short-term Trading
AbstractIn a market with short term agents and heterogeneous information, when liquidity trading displays persistence, prices reflect average expectations about fundamentals and liquidity trading. Informed investors exploit a private learning channel to infer the demand of liquidity traders from the order flow to anticipate the evolution of the future aggregate demand for the stock. This yields multiple equilibria which can be ranked in terms of liquidity and informational effciency. Our results have implications for the impact of High Frequency Trading (HFT) on market quality and for the role of average expectations inasset pricing. We show that with persistence HFT can enhance informational efficiency and liquidity -- though creating an unstable equilibrium. In the equilibrium with high (low) informational effciency, prices are closer to (farther away from) fundamentals compared to consensus estimates.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8303.
Date of creation: Mar 2011
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Other versions of this item:
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-02 (All new papers)
- NEP-CBA-2011-04-02 (Central Banking)
- NEP-CTA-2011-04-02 (Contract Theory & Applications)
- NEP-MST-2011-04-02 (Market Microstructure)
- NEP-UPT-2011-04-02 (Utility Models & Prospect Theory)
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