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A Comparison of Stock Market Mechanism

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    Abstract

    I analyze a static, noisy rational expectations equilibrium model where traders exchange vectors of assets accessing multi-dimensional information under two alternative market structures. In the first (the unrestricted system), informed speculators condition their demands for each asset on all equilibrium prices and market makers set prices observing all order flows; in the second (the restricted system), speculators are restricted to condition their demand on the price of the asset they want to trade and market makers only observe the order flow of the asset they price. I show that informed traders' incentives to collect and exploit multi-dimensional private information depend on the number of prices they can condition upon when submitting their demand schedules, and on the specific price formation process one considers. Building on this insight, I then give conditions under which the restricted system is more efficient than the unrestricted system.

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    Bibliographic Info

    Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 94.

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    Date of creation: 02 Apr 2003
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    Publication status: Published in RAND Journal of Economics, 2004, vol. 35, pages 803-824
    Handle: RePEc:sef:csefwp:94

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    Keywords: financial economics; asset pricing; information and market efficiency; market mechanisms;

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    1. Robert Gertner & Robert Gibbons & David Scharfstein, 1988. "Simultaneous Signalling to the Capital and Product Markets," RAND Journal of Economics, The RAND Corporation, vol. 19(2), pages 173-190, Summer.
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    3. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, vol. 22(3), pages 477-498, June.
    4. 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.
    5. Biais, Bruno, 1993. " Price Information and Equilibrium Liquidity in Fragmented and Centralized Markets," Journal of Finance, American Finance Association, vol. 48(1), pages 157-85, March.
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    7. Grossman, Sanford J, 1992. "The Informational Role of Upstairs and Downstairs Trading," The Journal of Business, University of Chicago Press, vol. 65(4), pages 509-28, October.
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    9. Vives, X., 1993. "Short-Term Investment and the Informational Efficiency of the Market," UFAE and IAE Working Papers 207.93, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    10. Nicholas Economides & Robert A. Schwartz, 1993. "Electronic Call Market Trading," Working Papers 93-19, New York University, Leonard N. Stern School of Business, Department of Economics.
    11. Rochet, Jean-Charles & Vila, Jean-Luc, 1994. "Insider Trading without Normality," Review of Economic Studies, Wiley Blackwell, vol. 61(1), pages 131-52, January.
    12. Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-57, May.
    13. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September.
    14. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
    15. Pagano, Marco & Roell, Ailsa, 1996. " Transparency and Liquidity: A Comparison of Auction and Dealer Markets with Informed Trading," Journal of Finance, American Finance Association, vol. 51(2), pages 579-611, June.
    16. Frederic Palomino, 2001. "Informational efficiency: ranking markets," Economic Theory, Springer, vol. 18(3), pages 683-700.
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