Dynamic Price Discovery: Transparency vs. Information Design

62 Pages Posted: 5 Jan 2019 Last revised: 2 Jul 2019

See all articles by Ali Kakhbod

Ali Kakhbod

Massachusetts Institute of Technology (MIT) - Department of Economics

Fei Song

Massachusetts Institute of Technology (MIT), Department of Economics

Date Written: December 1, 2018

Abstract

This paper studies how public disclosure of past trade details affects price discovery dynamics under asymmetric information with heterogenous hedging motives. We model that an informed buyer (informed trader) sequentially trades with a series of uninformed sellers (hedgers). The informed buyer is forward-looking and risk-neutral, and uninformed sellers are myopic and heterogeneously risk-averse. We discover that sellers’ price discovery over the underlying fundamentals is crucially affected by what they can observe about past trade details. Specifically, (i) the availability of past trade details, paradoxically, makes it easier for the informed party to hide her private information and offer opaque prices. (ii) Post-trade price transparency delays price discovery, but once it happens, it is always perfect. (iii) In contrast, when only past order information is available, price discovery can never be perfect, and can even be in the wrong direction. We establish that, under some minor regularity conditions, our equilibrium characterization achieves the maximal degree of ignorance among all pure-strategy PBE. Hence, this paper can be viewed as a worst case analysis for regulators who care about market transparency. Moreover, we show that our findings are robust when the informed party’s bargaining power decreases in the length of past trade history. Finally, we extend our results to the case where the informed buyer has a non-zero outside option, and the case where both parties switch their trading positions.

Keywords: Price Discovery. Information design. Asymmetric Information. Heterogenous Risk-aversion. Incentive. Public Offer vs. Private Offer.

JEL Classification: G14, G18, D83, G01

Suggested Citation

Kakhbod, Ali and Song, Fei, Dynamic Price Discovery: Transparency vs. Information Design (December 1, 2018). Available at SSRN: https://ssrn.com/abstract=3304186 or http://dx.doi.org/10.2139/ssrn.3304186

Ali Kakhbod (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

Fei Song

Massachusetts Institute of Technology (MIT), Department of Economics ( email )

77 Massachusetts Avenue
50 Memorial Drive
Cambridge, MA 02139-4307
United States

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