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Bid-ask price competition with asymmetric information between market makers

  • CALCAGNO, Riccardo

    ()

    (Center for Operations Research and Econometrics (CORE), Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

  • LOVO, Stefano M.

    ()

    (Center for Operations Research and Econometrics (CORE), Université catholique de Louvain (UCL), Louvain la Neuve, Belgium)

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    We consider the effect of asymmetric information on price formation process in a financial market where private information is held by a market maker. A Bayesian game is proposed in which there is price competition between two market makers with two different information partitions. At each stage players set bid and ask prices simultaneously and then trade occurs between market maker who proposes the most profitable price and liquidity traders. We characterize a set of partially revealing equilibria where the informed market maker's prices do not convey his private information. Informed player's equilibrium payoffsare proportional to prior beliefs of the market.

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    File URL: http://alfresco.uclouvain.be/alfresco/download/attach/workspace/SpacesStore/6dd748b2-025a-4c98-bd63-a4e4b8243b83/coredp_1998_16.pdf
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    Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 1998016.

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    Date of creation: 01 Feb 1998
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    Handle: RePEc:cor:louvco:1998016
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    1. David M Kreps & Robert Wilson, 2003. "Sequential Equilibria," Levine's Working Paper Archive 618897000000000813, David K. Levine.
    2. Benabou, R. & Laroque, G., 1988. "Using Privileged Information To Manipulate Markets: Insiders, Gurus And Credibility," Papers 19, Princeton, Woodrow Wilson School - Discussion Paper.
    3. 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.
    4. Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    5. Geanakoplos, John, 1994. "Common knowledge," Handbook of Game Theory with Economic Applications, in: R.J. Aumann & S. Hart (ed.), Handbook of Game Theory with Economic Applications, edition 1, volume 2, chapter 40, pages 1437-1496 Elsevier.
    6. Hendricks, Kenneth & Porter, Robert H. & Wilson, Charles A., 1990. "Auctions For Oil And Gas Leases With An Informed Bidder And A Random Reservation Price," Working Papers 90-47, C.V. Starr Center for Applied Economics, New York University.
    7. Dennert, Jurgen, 1993. "Price Competition between Market Makers," Review of Economic Studies, Wiley Blackwell, vol. 60(3), pages 735-51, July.
    8. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-81, September.
    9. Easley, David & O'Hara, Maureen, 1992. " Time and the Process of Security Price Adjustment," Journal of Finance, American Finance Association, vol. 47(2), pages 576-605, June.
    10. Paul Milgrom & Nancy L.Stokey, 1979. "Information, Trade, and Common Knowledge," Discussion Papers 377R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    11. Grossman, Sanford J & Stiglitz, Joseph E, 1976. "Information and Competitive Price Systems," American Economic Review, American Economic Association, vol. 66(2), pages 246-53, May.
    12. Kyle, Albert S, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Wiley Blackwell, vol. 56(3), pages 317-55, July.
    13. Engelbrecht-Wiggans, Richard & Milgrom, Paul R. & Weber, Robert J., 1983. "Competitive bidding and proprietary information," Journal of Mathematical Economics, Elsevier, vol. 11(2), pages 161-169, April.
    14. Radner, Roy, 1979. "Rational Expectations Equilibrium: Generic Existence and the Information Revealed by Prices," Econometrica, Econometric Society, vol. 47(3), pages 655-78, May.
    15. Biais, Bruno & Martimort, David & Rochet, Jean-Charles, 1998. "Competing Mechanisms in a Commun Value Environment," IDEI Working Papers 75, Institut d'Économie Industrielle (IDEI), Toulouse.
    16. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
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