Welfare Costs of Informed Trade

AFA 2016 San Francisco Meetings

Columbia Business School Research Paper No. 16-58

46 Pages Posted: 23 Aug 2016 Last revised: 2 Jan 2020

See all articles by Lawrence R. Glosten

Lawrence R. Glosten

Columbia Business School - Finance and Economics

Tālis J. Putniņš

University of Technology Sydney (UTS); Stockholm School of Economics, Riga

Date Written: November 5, 2019

Abstract

We examine the welfare costs of informed trade in a new sequential trade model with elastic uninformed traders. Welfare losses occur when the liquidity costs of executing a trade exceed the potential gains from the trade. With long-lived private information, more informed traders lead to better liquidity and less welfare losses because the benefits of faster price discovery outweigh the costs of wider initial spreads. For short-lived information, this tradeoff does not materialize and welfare losses increase with the amount of informed trade. Our findings suggest that regulation of informed trade should consider the horizon of private information.

Keywords: market microstructure, welfare, liquidity, informed trading, insider trading

JEL Classification: G14, K22

Suggested Citation

Glosten, Lawrence R. and Putnins, Talis J., Welfare Costs of Informed Trade (November 5, 2019). AFA 2016 San Francisco Meetings, Columbia Business School Research Paper No. 16-58, Available at SSRN: https://ssrn.com/abstract=2827158 or http://dx.doi.org/10.2139/ssrn.2827158

Lawrence R. Glosten

Columbia Business School - Finance and Economics ( email )

3022 Broadway
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Talis J. Putnins (Contact Author)

University of Technology Sydney (UTS) ( email )

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Sydney
Australia
+61 2 9514 3088 (Phone)

Stockholm School of Economics, Riga ( email )

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Latvia
+371 67015841 (Phone)

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