Strategic Trading with Fundamental and Non-Fundamental Information
Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)
Cheung Kong Graduate School of Business
March 31, 2012
We study strategic trading with both fundamental information about the stock payoff and non-fundamental information in an infinite-horizon continuous-time model. The trading regarding non-fundamental information is caused by the predictability of informed trading (due to risk aversion) or the predictability of noise supply. Because of the interaction between the two types of information, the equilibrium stock price is not fully revealing, although the informed monopolist may trade infinitely aggressively. This result holds even when the informed monopolist is risk neutral and noise supply follows a mean-reverting process. In contrast, the price is fully-revealing in previous stationary strategic models. As the information monopolist is more risk averse, the price impact decreases for a small value of private fundamental information but increases for a large value. We also show that the informed monopolist's order flow in the current period and his inventory position in the previous period can exhibit simultaneously positive forecasting powers for future stock returns.
Number of Pages in PDF File: 70
Keywords: Strategic trading, fundamental information and non-fundamental information, risk aversion, mean-reverting noise trading, price efficiency
JEL Classification: D11, D91, G11, G14working papers series
Date posted: March 31, 2012
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