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Giffen goods and market making

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  • Giovanni Cespa

Abstract

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

Suggested Citation

  • Giovanni Cespa, 2005. "Giffen goods and market making," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 25(4), pages 983-997, June.
    • Handle: RePEc:spr:joecth:v:25:y:2005:i:4:p:983-997
    DOI: 10.1007/s00199-003-0461-5
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    Cited by:

    1. Giovanni Cespa, 2004. "A Comparison of Stock Market Mechanisms," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 803-824, Winter.
    2. Giovanni Cespa & Xavier Vives, 2015. "The Beauty Contest and Short-Term Trading," Journal of Finance, American Finance Association, vol. 70(5), pages 2099-2154, October.
    3. Giovanni Cespa & Xavier Vives, 2011. "Expectations, Liquidity, and Short-term Trading," CESifo Working Paper Series 3390, CESifo.

    More about this item

    Keywords

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    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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