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Strategic behavior and price discovery

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  • Luis A. Medrano
  • Xavier Vives

Abstract

The paper analyzes the effects of strategic behavior by an insider in a price discovery process, akin to an information tatonnement, in the presence of a competitive informed sector. Such processes are used in the preopening period of continuous trading systems in several exchanges. It is found that the insider manipulates the market using a contrarian strategy in order to neutralize the effect of the trades of competitive informed agents. Furthermore, consistently with the empirical evidence available, we find that information revelation accelerates close to the opening, that the market price does not converge to the fundamental value no matter how many rounds the tatonnement has, and that the expected trading volume displays a U-shaped pattern. We also find that a market with a larger competitive sector (smaller insider) has an improved informational efficiency and an increased trading volume. The insider provides a public good (a lower informativeness of the price) for the competitive informed sector.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 238.

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Date of creation: Sep 1997
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Handle: RePEc:upf:upfgen:238

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Web page: http://www.econ.upf.edu/

Related research

Keywords: Market manipulation; contrarian behavior; preopening auction; information atonnement; market microestructure; insider trading;

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Cited by:
  1. Werner Stanzl & Gur Huberman, 2000. "Arbitrage-Free Price-Update and Price-Impact Functions," Yale School of Management Working Papers ysm164, Yale School of Management, revised 01 Jan 2001.
  2. Sandro Brusco & Carolina Manzano & Mikel Tapia, 2003. "Price Discovery In The Pre-Opening Period. Theory And Evidence From The Madrid Stock Exchange," Business Economics Working Papers wb035814, Universidad Carlos III, Departamento de Economía de la Empresa.
  3. Barclay, Michael J. & Hendershott, Terrence, 2008. "A comparison of trading and non-trading mechanisms for price discovery," Journal of Empirical Finance, Elsevier, vol. 15(5), pages 839-849, December.
  4. Ryan Davies, 2000. "Registered trader participation during the Toronto Stock Exchange's pre-opening session," Working Papers 997, Queen's University, Department of Economics.
  5. Biais, Bruno & Glosten, Larry & Spatt, Chester, 2004. "Market Microstructure: A Survey of Microfoundations, Empirical Results, and Policy Implications," IDEI Working Papers 253, Institut d'Économie Industrielle (IDEI), Toulouse.
  6. Davies, Ryan J., 2003. "The Toronto Stock Exchange preopening session," Journal of Financial Markets, Elsevier, vol. 6(4), pages 491-516, August.
  7. Comerton-Forde, Carole & Rydge, James, 2006. "The influence of call auction algorithm rules on market efficiency," Journal of Financial Markets, Elsevier, vol. 9(2), pages 199-222, May.

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