Arrow-Debreu Meets Kyle

Abstract

We extend the Kyle (1985) setting to an Arrow-Debreu economy with information asymmetry regarding Arrow-Debreu state probabilities. Equivalently, the informed agent has private information regarding arbitrary aspects of the payoff distribution of an underlying asset and trades a complete menu of options. No parametric assumption is made on the possible payoff distributions or the nature of private information. We characterize the informed demand, information efficiency of Arrow-Debreu prices, and price impact within and across Arrow-Debreu markets. Information asymmetry regarding higher moments is a special case, where informed demand recovers corresponding options trading strategies used in practice, such as volatility straddle.

Keywords: Arrow-Debreu Markets; Options; Price Discovery; Volatility Straddle.

JEL Classification: C61, G13, G14.