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Information-Based Trading

Author

Listed:
  • George Bouzianis
  • Lane P. Hughston
  • Leandro S'anchez-Betancourt

Abstract

We consider a pair of traders in a market where the information available to the second trader is a strict subset of the information available to the first trader. The traders make prices based on the information available concerning a security that pays a random cash flow at a fixed time $T$ in the future. Market information is modelled in line with the scheme of Brody, Hughston & Macrina (2007, 2008) and Brody, Davis, Friedman & Hughston (2009). The risk-neutral distribution of the cash flow is known to the traders, who make prices with a fixed multiplicative bid-offer spread and report their prices to a game master who declares that a trade has been made when the bid price of one of the traders crosses the offer price of the other. We prove that the value of the first trader's position is strictly greater than that of the second. The results are analyzed by use of simulation studies and generalized to situations where (a) there is a hierarchy of traders, (b) there are multiple successive trades, and (c) there is inventory aversion.

Suggested Citation

  • George Bouzianis & Lane P. Hughston & Leandro S'anchez-Betancourt, 2022. "Information-Based Trading," Papers 2201.08875, arXiv.org, revised Jan 2024.
    • Handle: RePEc:arx:papers:2201.08875
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    References listed on IDEAS

    as
    1. Damir Filipović & Lane P. Hughston & Andrea Macrina, 2012. "Conditional Density Models For Asset Pricing," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 15(01), pages 1-24.
    2. Marek Rutkowski & Nannan Yu, 2007. "An Extension Of The Brody–Hughston–Macrina Approach To Modeling Of Defaultable Bonds," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 10(03), pages 557-589.
    3. Edward Hoyle, 2010. "Information-based models for finance and insurance," Papers 1010.0829, arXiv.org.
    4. Dothan, Michael U., 1990. "Prices in Financial Markets," OUP Catalogue, Oxford University Press, number 9780195053128.
    5. Lane P. Hughston & Leandro Sánchez-Betancourt, 2020. "Pricing with Variance Gamma Information," Risks, MDPI, vol. 8(4), pages 1-22, October.
    6. Dorje C. Brody & Lane P. Hughston & Ewan Mackie, 2011. "General Theory of Geometric L\'evy Models for Dynamic Asset Pricing," Papers 1111.2169, arXiv.org, revised Jan 2012.
    7. Lane P. Hughston & Leandro S'anchez-Betancourt, 2020. "Pricing with Variance Gamma Information," Papers 2003.07967, arXiv.org, revised Sep 2020.
    8. Damir Filipović & Lane P. Hughston & Andrea Macrina, 2012. "Conditional Density Models For Asset Pricing," World Scientific Book Chapters, in: Matheus R Grasselli & Lane P Hughston (ed.), Finance at Fields, chapter 9, pages 225-248, World Scientific Publishing Co. Pte. Ltd..
    9. Dorje C. Brody & Lane P. Hughston & Andrea Macrina, 2022. "Information-Based Asset Pricing," World Scientific Book Chapters, in: Dorje Brody & Lane Hughston & Andrea Macrina (ed.), Financial Informatics An Information-Based Approach to Asset Pricing, chapter 2, pages 29-64, World Scientific Publishing Co. Pte. Ltd..
    10. Dorje C. Brody & Lane P. Hughston & Andrea Macrina, 2008. "Information-Based Asset Pricing," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 11(01), pages 107-142.
    11. Lane P. Hughston & Andrea Macrina, 2012. "Pricing Fixed-Income Securities in an Information-Based Framework," Applied Mathematical Finance, Taylor & Francis Journals, vol. 19(4), pages 361-379, September.
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