Giffen Goods and Market Making

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Giffen Goods and Market Making

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Giovanni Cespa

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Giovanni Cespa

Abstract

This paper shows that information effects per se are not responsible for the Giffen goods anomaly affecting competitive traders’ demands in multi- asset, noisy rational expectations equilibrium models. The role that information plays in traders’ strategies also matters. In a market with risk averse, uninformed traders, informed agents have a dual motive for trading: speculation and market making. While speculation entails using prices to assess the effect of private signal error terms, market making requires employing them to disentangle noise traders’ effects in traders’ aggregate orders. In a correlated environment, this complicates a trader’s signal-extraction problem and may generate upward-sloping demand curves. Assuming either (i) that competitive, risk neutral market makers price the assets, or that (ii) the risk tolerance coefficient of uninformed traders grows without bound, removes the market making component from informed traders’ demands, rendering them well behaved in prices.

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 681.

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Date of creation: Apr 2002
Date of revision: May 2003
Handle: RePEc:upf:upfgen:681

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Other versions of this item:

Article
- Giovanni Cespa, 2005. "Giffen goods and market making," Economic Theory, Springer, vol. 25(4), pages 983-997, 06. [Downloadable!] (restricted)
Paper
- Giovanni Cespa, 2003. "Giffen Goods and Market Making," CSEF Working Papers 97, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]

Find related papers by JEL classification:
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

References listed on IDEAS
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Vives, Xavier, 1995. "Short-Term Investment and the Informational Efficiency of the Market," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 8(1), pages 125-60. [Downloadable!] (restricted)
Other versions:
- 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).
- Xavier Vives, 1994. "Short-term Investment and the Informational Efficiency of the Market," CEPR Financial Markets Paper 0034, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 53--56 Great Sutton Street, London EC1V 0DG.
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. [Downloadable!] (restricted)
Giovanni Cespa, 2004. "A Comparison of Stock Market Mechanisms," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 803-824, Winter.
Other versions:
- Giovanni Cespa, 2001. "A Comparison of Stock Market Mechanisms," Economics Working Papers 545, Department of Economics and Business, Universitat Pompeu Fabra, revised Nov 2003. [Downloadable!]
- Giovanni Cespa, 2003. "A Comparison of Stock Market Mechanisms," CSEF Working Papers 94, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy. [Downloadable!]
Cespa, Giovanni, 2002. "Short-term investment and equilibrium multiplicity," European Economic Review, Elsevier, vol. 46(9), pages 1645-1670, October. [Downloadable!] (restricted)
Other versions:
- Giovanni Cespa, 2000. "Short-term Investment and Equilibrium Multiplicity," Economics Working Papers 520, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 2002. [Downloadable!]
Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December. [Downloadable!] (restricted)
Other versions:
- Gerard Gennotte and Hayne Leland., 1989. "Market Liquidity, Hedging and Crashes," Research Program in Finance Working Papers RPF-184, University of California at Berkeley.
- Gerard Gennotte and Hayne Leland., 1989. "Market Liquidity, Hedging and Crashes," Research Program in Finance Working Papers RPF-192, University of California at Berkeley.
Gadi Barlevy & Pietro Veronesi, 2000. "Rational Panics and Stock Market Crashes," CRSP working papers 483, Center for Research in Security Prices, Graduate School of Business, University of Chicago. [Downloadable!]
Other versions:
- Barlevy, Gadi & Veronesi, Pietro, 2003. "Rational panics and stock market crashes," Journal of Economic Theory, Elsevier, vol. 110(2), pages 234-263, June. [Downloadable!] (restricted)
Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November. [Downloadable!] (restricted)
Bhattacharya Utpal & Reny Philip J. & Spiegel Matthew, 1995. "Destructive Interference in an Imperfectly Competitive Multi-Security Market," Journal of Economic Theory, Elsevier, vol. 65(1), pages 136-170, February. [Downloadable!] (restricted)
Other versions:
- Reny, P.J. & Bhattacharya, U. & Spiegel, M., 1993. "Destructive Interference in an Imperfectly Competitive Multi-Security Market," UWO Department of Economics Working Papers 9318, University of Western Ontario, Department of Economics.
Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-57, May. [Downloadable!] (restricted)
Vives, X., 1992. "The Speed of Information Revelation in a Financial Market Mechanism," UFAE and IAE Working Papers 174.92, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
Other versions:
- Xavier Vives, 1992. "The Speed of Information Revelation in a Financial Market Mechanism," CEPR Financial Markets Paper 0016, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 53--56 Great Sutton Street, London EC1V 0DG.
- Vives Xavier, 1995. "The Speed of Information Revelation in a Financial Market Mechanism," Journal of Economic Theory, Elsevier, vol. 67(1), pages 178-204, October. [Downloadable!] (restricted)
Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, vol. 22(3), pages 477-498, June. [Downloadable!] (restricted)

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