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Market efficiency and Price Formation when Dealers are Asymmetrically Informed

Author

Listed:
  • LOVO, Stefano M.
  • CALCAGNO, R.

    (Tilburg University)

Abstract

We consider the effect of asymmetric information on price formation process in a quote-driven market where one market maker receives a private signal on the security's fundamental. A model is presented where market makers repeatedly compete in prices: at each stage a bid-ask auction occurs and the winner trades the security against liquidity traders. We show that at equilibrium the market is not strong-form efficient until the last stage. We characterize a reputational equilibrium in which the informed market maker will aspect market beliefs, possibly misleading them, in the sense that he will push the uninformed participants to think the value of the risky asset is different from the realized one. At this equilibrium a price leadership effect arises, quotes are never equal to the expected value of the asset given the public information, the informed market maker expected payoff is positive and the information revelation speed is slower than in an analogous order-driven market.

Suggested Citation

  • LOVO, Stefano M. & CALCAGNO, R., 2001. "Market efficiency and Price Formation when Dealers are Asymmetrically Informed," Les Cahiers de Recherche 737, HEC Paris.
  • Handle: RePEc:ebg:heccah:0737
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    File URL: http://www.hec.fr/var/fre/storage/original/application/2f3701d659b4b4eaf0cc31e7b661efbe.pdf
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    References listed on IDEAS

    as
    1. Riccardo Calcagno & Stefano Lovo, 2006. "Bid-Ask Price Competition with Asymmetric Information between Market-Makers," Review of Economic Studies, Oxford University Press, vol. 73(2), pages 329-355.
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    Cited by:

    1. Thierry Foucault & Sophie Moinas & Erik Theissen, 2007. "Does Anonymity Matter in Electronic Limit Order Markets?," Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1707-1747, 2007 28.

    More about this item

    Keywords

    bid-ask prices; asymmetric information; repeated auction; insider trading;

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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