Abstract
We analyze security price formation in a dynamic setting in which long-lived dealers repeatedly compete for trading with potentially informed retail traders. For a class of market microstructure models, we characterize equilibria in which dealers’ dynamic pricing strategies are optimal no matter the private information each dealer may possess. In a generalized version of the Glosten and Milgrom model, these equilibria deliver price dynamics reminiscent of well-known stylized facts: price/trading-flow correlation, volatility clustering, price bubble and inventory/inter-dealer trading correlation.
Keywords
Financial Market Microstructure; Belief-free Equilibria; Informed Market Makers; Price Volatility;
JEL codes
- C72: Noncooperative Games
- C73: Stochastic and Dynamic Games • Evolutionary Games • Repeated Games
- G1: General Financial Markets
- G12: Asset Pricing • Trading Volume • Bond Interest Rates
Replaces
Johannes Hörner, and Stefano Lovo, “Belief-free Price Formation”, TSE Working Paper, n. 17-790, March 2017.
Reference
Johannes Hörner, Stefano Lovo, and Tristan Tomala, “Belief-free Price Formation”, Journal of Financial Economics, vol. 127, n. 2, February 2018, pp. 342–365.
See also
Published in
Journal of Financial Economics, vol. 127, n. 2, February 2018, pp. 342–365