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Insider trading, stochastic liquidity and equilibrium prices

Author: Pierre Collin Dufresne; Vyacheslav Fos; National Bureau of Economic Research.
Publisher: Cambridge, Mass. : National Bureau of Economic Research, ©2012.
Series: Working paper series (National Bureau of Economic Research), no. 18451.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
We extend Kyle's (1985) model of insider trading to the case where liquidity provided by noise traders follows a general stochastic process. Even though the level of noise trading volatility is observable, in equilibrium, measured price impact is stochastic. If noise trading volatility is mean-reverting, then the equilibrium price follows a multivariate 'stochastic bridge' process, which displays stochastic  Read more...
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Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: Pierre Collin Dufresne; Vyacheslav Fos; National Bureau of Economic Research.
OCLC Number: 813044707
Notes: Title from http://www.nber.org/papers/18451 viewed October 16, 2012.
"October 2012."
Description: 1 online resource (48 pages) : illustrations.
Series Title: Working paper series (National Bureau of Economic Research), no. 18451.
Responsibility: Pierre Collin-Dufresne, Vyacheslav Fos.

Abstract:

We extend Kyle's (1985) model of insider trading to the case where liquidity provided by noise traders follows a general stochastic process. Even though the level of noise trading volatility is observable, in equilibrium, measured price impact is stochastic. If noise trading volatility is mean-reverting, then the equilibrium price follows a multivariate 'stochastic bridge' process, which displays stochastic volatility. This is because insiders choose to optimally wait to trade more aggressively when noise trading activity is higher. In equilibrium, market makers anticipate this, and adjust prices accordingly. More private information is revealed when volatility is higher. In time series, insiders trade more aggressively, when measured price impact is lower. Therefore, execution costs to uninformed traders can be higher when price impact is lower.

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