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Basic conditions for costless signalling in financial markets

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  • Franke, Günter

Abstract

A costless, fully revealing signalling equilibrium is derived from two easily understandable conditions. The outsidet-protection condition states that the outsiders relate the price which they offer to pay for a security inversely to the supply of this security which they interpret as a quality signal. Thereby they attempt to protect themselves against adverse selection. The noarbitrage condition requires that the exchange rate for two securities must be the same in both primary and secondary markets. These conditions have strong implications for the valuation of securities and optimal insider policies. Therefore a costless signalling equilibrium is obtained.

Suggested Citation

  • Franke, Günter, 1985. "Basic conditions for costless signalling in financial markets," Discussion Papers, Series C 7, University of Konstanz, Department of Economics.
  • Handle: RePEc:zbw:kondpc:7
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    1. Stephen A. Ross, 1977. "The Determination of Financial Structure: The Incentive-Signalling Approach," Bell Journal of Economics, The RAND Corporation, vol. 8(1), pages 23-40, Spring.
    2. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
    3. Leland, Hayne E & Pyle, David H, 1977. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Journal of Finance, American Finance Association, vol. 32(2), pages 371-387, May.
    4. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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