Information-Based Trading and the Bid-Ask Spread

23 Pages Posted: 15 Sep 2010

See all articles by Kee H. Chung

Kee H. Chung

State University of New York at Buffalo - School of Management

Jing Jiang

Sacred Heart University - Jack Welch College of Business, Department of Economics and Finance

Date Written: September 14, 2010

Abstract

We analyze the equilibrium spread when the transaction size of informed traders is elastic in the value of private information (α). We show that the pooling equilibrium is likely to be inefficient when trade size is sensitive to α and the inefficient equilibrium can occur before the market breaks down. The pooling equilibrium spread does not monotonically increase with α, although it increases with the elasticity of informed trades to α. The upper bound of the elasticity of informed trades for the market to remain open for the active specialist is higher than the corresponding value for the passive specialist when the specialist has enough leverage over brokers.

Keywords: Spread, Specialist, Passive vs. Active Equilibrium, Informed Trading

JEL Classification: G18, G19

Suggested Citation

Chung, Kee H. and Jiang, Jing, Information-Based Trading and the Bid-Ask Spread (September 14, 2010). Available at SSRN: https://ssrn.com/abstract=1676952 or http://dx.doi.org/10.2139/ssrn.1676952

Kee H. Chung (Contact Author)

State University of New York at Buffalo - School of Management ( email )

Buffalo, NY 14260
United States
716-645-3262 (Phone)
716-645-3823 (Fax)

HOME PAGE: http://mgt.buffalo.edu/faculty/academic-departments/finance/faculty/kee-chung.html

Jing Jiang

Sacred Heart University - Jack Welch College of Business, Department of Economics and Finance ( email )

5151 Park Avenue
Fairfield, CT 06432
United States

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