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Equilibrium Pricing and Trading Volume under Preference Uncertainty

Author

Listed:
  • 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," TSE Working Papers 13-422, Toulouse School of Economics (TSE).
  • Handle: RePEc:tse:wpaper:27433
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    Cited by:

    1. Bruno Biais & Fany Declerck & Sophie Moinas, 2016. "Who supplies liquidity, how and when?," BIS Working Papers 563, Bank for International Settlements.
    2. repec:bpj:jossai:v:4:y:2016:i:1:p:24-39:n:2 is not listed on IDEAS
    3. Andrea M. Buffa & Suleyman Basak, 2016. "A Theory of Operational Risk," 2016 Meeting Papers 352, Society for Economic Dynamics.
    4. repec:eee:appene:v:203:y:2017:i:c:p:154-163 is not listed on IDEAS
    5. Abbassi, Puriya & Fecht, Falko & Tischer, Johannes, 2015. "The intraday interest rate: What's that?," Discussion Papers 24/2015, Deutsche Bundesbank.

    More about this item

    JEL classification:

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

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