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Equilibrium Pricing and Trading Volume under Preference Uncertainty

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  • Biais, Bruno
  • Hombert, Johan
  • Weill, Pierre-Olivier

Abstract

Information collection, processing and dissemination financial institutions is challenging. This can delay the observation by traders of the exact capital charges and constraints of their institution. During this delay, traders face preference uncertainty. In this context, we study optimal trading strategies and equilibrium prices in a continuous centralized market. We focus on liquidity shocks, during which preference uncertainty is likely to matter most. Preference uncertainty generates allocative ineficiency, but need not reduce prices. Traders progressively learning about the preferences of their institution conduct round-trip trades, which generate excess volume relative to the frictionless market. In a cross section of liquidity shocks, the initial price drop is positively correlated with total trading volume. Across traders, the number of round-trips is negatively correlated with trading profits and average inventory.

Suggested Citation

  • Biais, Bruno & Hombert, Johan & Weill, Pierre-Olivier, 2013. "Equilibrium Pricing and Trading Volume under Preference Uncertainty," IDEI Working Papers 787, Institut d'Économie Industrielle (IDEI), Toulouse, revised Dec 2013.
  • Handle: RePEc:ide:wpaper:27434
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    References listed on IDEAS

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    1. Ana Babus & Péter Kondor, 2018. "Trading and Information Diffusion in Over‐the‐Counter Markets," Econometrica, Econometric Society, vol. 86(5), pages 1727-1769, September.
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    Cited by:

    1. Marvin Wee & Joey W. Yang, 2016. "The Evolution of Informed Liquidity Provision: Evidence from an Order†driven Market," European Financial Management, European Financial Management Association, vol. 22(5), pages 882-915, November.
    2. Bruno Biais & Fany Declerck & Sophie Moinas, 2016. "Who supplies liquidity, how and when?," BIS Working Papers 563, Bank for International Settlements.
    3. Julien Hugonnier & Benjamin Lester & Pierre-Olivier Weill, 2020. "Frictional Intermediation in Over-the-Counter Markets," Review of Economic Studies, Oxford University Press, vol. 87(3), pages 1432-1469.
    4. Puriya Abbassi & Falko Fecht & Johannes Tischer, 2017. "Variations in Market Liquidity and the Intraday Interest Rate," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(4), pages 733-765, June.
    5. Andrea M. Buffa & Suleyman Basak, 2016. "A Theory of Operational Risk," 2016 Meeting Papers 352, Society for Economic Dynamics.
    6. Pierre-Olivier Weill, 2020. "The search theory of OTC markets," NBER Working Papers 27354, National Bureau of Economic Research, Inc.
    7. Guan, Qing & An, Haizhong, 2017. "The exploration on the trade preferences of cooperation partners in four energy commodities’ international trade: Crude oil, coal, natural gas and photovoltaic," Applied Energy, Elsevier, vol. 203(C), pages 154-163.
    8. Abbassi, Puriya & Fecht, Falko & Tischer, Johannes, 2015. "The intraday interest rate: What's that?," Discussion Papers 24/2015, Deutsche Bundesbank.
    9. Zhou Yongwu & Lin Zhaozhan, 2016. "Impacts of Hyperbolic Discounting on Inventory Replenishment Policy Under Inflation," Journal of Systems Science and Information, De Gruyter, vol. 4(1), pages 24-39, February.

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    More about this item

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G1 - Financial Economics - - General Financial Markets

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