Belief-Free Price Formation
HEC Paris - Finance Department
HEC Paris - Economics & Decision Sciences
Yale University - Cowles Foundation
May 9, 2012
Paris December 2012 Finance Meeting EUROFIDAI-AFFI Paper
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 that each dealer has about the economy fundamentals. In a generalization of the Glosten and Milgrom model, these equilibria generate price dynamics that are reminiscent of well known stylized facts: price/trading-flow correlation, volatility clustering, price bubble and inventory/inter-dealer trading correlation.
Number of Pages in PDF File: 38
Keywords: Financial Market Microstructure, Belief-free Equilibria, Informed Market Makers, Price Volatility
JEL Classification: G1, G12, C72, C73working papers series
Date posted: May 14, 2012
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