Do Rational Traders Frenzy?
42 Pages Posted: 22 Jun 1997
Date Written: April 1996
I develop a simple new model of strategic trade with endogenous timing, generalizing Glosten and Milgrom (1985): A competitive market maker faces in risk neutral traders with unit demands or supplies. It is private information whether any given trader is either informed, with a heterogeneous informative signal about the asset payo , or a pure noise trader planning to make a trade at a random time. The market is open for an exponential length of time. This structure is recursively soluble into a sequence of "subgames", and (despite the endogenous timing) I find there is a unique separating equilibrium. I prove that necessarily there is incomplete separation, since only informed traders whose signals are "good news" ever buy, and only those with "bad news" ever sell! I show that traders can only envision switching sides of the market if the underlying signal distribution has no neutral news signal. Finally, I conjecture that the answer to the title is "yes", that all trades are self-feeding, and accelerate the time schedule of any future trades. My analysis is greatly simplified by focusing on a facetious "competitive auction" model, where the market maker only wishes to sell units.
JEL Classification: G12, G14
Suggested Citation: Suggested Citation