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Intertemporal Price Discovery by Market Makers: Active versus Passive Learning

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Author Info
Chris J. Leach
Ananth N. Madhavan

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Abstract

This paper examines the role of the market maker in intertemporal price formation in securities market. We argue that the market maker, in performing the critical function of price discovery, may set prices in a dynamic context that would be suboptimal in a single period context in order to learn more from the resulting order flow. Such actions constitute an investment in the production of information. Necessary and sufficient conditions for the existence of such price strategies are developed and several examples are presented.

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Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 15-90.

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Handle: RePEc:fth:pennfi:15-90

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  1. Taylor, Mark P. & Schmidt, Markus & Reitz, Stefan, 2007. "End-user order flow and exchange rate dynamics," Discussion Paper Series 1: Economic Studies 2007,05, Deutsche Bundesbank, Research Centre. [Downloadable!]
  2. Victoria Saporta & Giorgio Trebeschi & Anne Vila, . "Price formation and transparency on the London Stock Exchange," Bank of England working papers 95, Bank of England. [Downloadable!]
  3. Osler, Carol & Mende, Alexander & Menkhoff, Lukas, 2006. "Price Discovery in Currency Markets," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-351, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
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This page was last updated on 2009-10-24.

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