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Giffen goods and market making

  • Giovanni Cespa


This paper shows that information effects per se are not responsible for the Giffen goods anomaly affecting traders’ demands in multi asset noisy, rational expectations equilibrium markets. The role that information plays in traders’ strategies also matters. In a market with risk averse, uninformed traders, informed agents have a dual trading motive: speculation and market making. The former entails using prices to assess the effect of error terms; the latter requires employing them to disentangle noise traders’ demands within aggregate orders. In a correlated environment this complicates the signal extraction problem and may generate upward sloping demand curves. Assuming (i) that competitive, risk neutral market makers price the assets or that (ii) uninformed traders’ risk tolerance coefficient grows unboundedly, removes the market making component from informed traders’ demands rendering them well behaved in prices. Copyright Springer-Verlag Berlin/Heidelberg 2005

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Article provided by Springer in its journal Economic Theory.

Volume (Year): 25 (2005)
Issue (Month): 4 (06)
Pages: 983-997

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Handle: RePEc:spr:joecth:v:25:y:2005:i:4:p:983-997
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  1. 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.
  2. 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.
  3. Admati, Anat R, 1985. "A Noisy Rational Expectations Equilibrium for Multi-asset Securities Markets," Econometrica, Econometric Society, vol. 53(3), pages 629-57, May.
  4. 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.
  5. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  6. Barlevy, Gadi & Veronesi, Pietro, 2003. "Rational panics and stock market crashes," Journal of Economic Theory, Elsevier, vol. 110(2), pages 234-263, June.
  7. Giovanni Cespa, 2000. "Short-term investment and equilibrium multiplicity," Economics Working Papers 520, Department of Economics and Business, Universitat Pompeu Fabra, revised Jun 2002.
  8. Gennotte, Gerard & Leland, Hayne, 1990. "Market Liquidity, Hedging, and Crashes," American Economic Review, American Economic Association, vol. 80(5), pages 999-1021, December.
  9. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
  10. Vives, Xavier, 1995. "Short-Term Investment and the Informational Efficiency of the Market," Review of Financial Studies, Society for Financial Studies, vol. 8(1), pages 125-60.
  11. Hellwig, Martin F., 1980. "On the aggregation of information in competitive markets," Journal of Economic Theory, Elsevier, vol. 22(3), pages 477-498, June.
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