1. Insider Trading, Stochastic Liquidity, and Equilibrium Prices
- Author
-
Pierre Collin-Dufresne and Vyacheslav Fos
- Subjects
jel:D80 ,Economics and Econometrics ,Asymmetric information ,jel:D84 ,jel:D82 ,jel:D83 ,Market maker ,jel:G00 ,Information asymmetry ,jel:G0 ,jel:G1 ,0502 economics and business ,Economics ,Econometrics ,Insider trading ,subordinate process ,Stochastic volatility ,050207 economics ,Private information retrieval ,volume ,Kyle model ,050208 finance ,Price impact ,Market depth ,05 social sciences ,Execution costs ,jel:G12 ,jel:G10 ,Market liquidity ,jel:G14 ,Continuous time ,Liquidity ,Brownian bridge ,jel:D4 ,Volatility (finance) ,jel:D8 - 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.
- Published
- 2016