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Bid-Ask Price Competition with Asymmetric Information between Market-Makers

  • Riccardo Calcagno
  • Stefano Lovo
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    This paper studies the effect of asymmetric information on the price formation process in a quote-driven market. One market-maker receives private information on the value of the quoted asset and repeatedly competes with market-makers who are uninformed. We show that despite the fact that the informed market-maker's quotes are public, the market is never strong-form efficient with certainty until the last stage. We characterize a reputational equilibrium in which the informed market-maker influences and possibly misleads the uninformed market-makers' beliefs. At this equilibrium, a price leadership effect arises, the informed market-maker's expected pay-off is positive and the rate of price discovery increases in the last stages of trade. Copyright 2006, Wiley-Blackwell.

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    File URL: http://hdl.handle.net/10.1111/j.1467-937X.2006.378_1.x
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    Article provided by Oxford University Press in its journal The Review of Economic Studies.

    Volume (Year): 73 (2006)
    Issue (Month): 2 ()
    Pages: 329-355

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    Handle: RePEc:oup:restud:v:73:y:2006:i:2:p:329-355
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