Equilibrium Pricing and Trading Volume under Preference Uncertainty
AbstractInformation collection, processing and dissemination financial institutions is challenging. This can delay the observation by traders of the exact capital charges and constraints of their institution. During this delay, traders face preference uncertainty. In this context, we study optimal trading strategies and equilibrium prices in a continuous centralized market. We focus on liquidity shocks, during which preference uncertainty is likely to matter most. Preference uncertainty generates allocative ineficiency, but need not reduce prices. Traders progressively learning about the preferences of their institution conduct round-trip trades, which generate excess volume relative to the frictionless market. In a cross section of liquidity shocks, the initial price drop is positively correlated with total trading volume. Across traders, the number of round-trips is negatively correlated with trading profi ts and average inventory.
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Bibliographic InfoPaper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 787.
Date of creation: 16 Jul 2013
Date of revision: Dec 2013
Publication status: Published in The Review of Economic Studies, 2014.
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Other versions of this item:
- Biais, Bruno & Hombert, Johan & Weill, Pierre-Olivier, 2013. "Equilibrium Pricing and Trading Volume under Preference Uncertainty," TSE Working Papers 13-422, Toulouse School of Economics (TSE).
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- G1 - Financial Economics - - General Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-09-13 (All new papers)
- NEP-MIC-2013-09-13 (Microeconomics)
- NEP-MST-2013-09-13 (Market Microstructure)
- NEP-UPT-2013-09-13 (Utility Models & Prospect Theory)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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"Trading and Information Diffusion in Over-the-Counter Markets,"
2013 Meeting Papers
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- Dumas, Bernard & Luciano, Elisa, 1991. " An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs," Journal of Finance, American Finance Association, vol. 46(2), pages 577-95, June.
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