Robust pricing under strategic trading

Aibo Gong, Shaowei Ke, Yawen Qiu and Rui Shen

Journal of Economic Theory, 2022, vol. 199, issue C

Abstract: We study strategic trading with a market maker who does not know the joint distribution of public information and an asset's value, and hence cannot interpret information properly. Following a public event, a probabilistically informed trader who knows the distribution and liquidity traders trade. The market maker adopts a robust linear pricing strategy that has the best worst-case payoff guarantee. We show that such a strategy is equivalent to a two-step learning procedure, and characterize the unique linear equilibrium. Expected equilibrium prices exhibit underreaction to public information. If the trading frequency is arbitrarily high, the market maker fully reveals the distribution in the price eventually.

Keywords: Robust pricing; Strategic trading; Ambiguity; Underreaction to public information (search for similar items in EconPapers)
JEL-codes: D53 D80 G00 G40 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:199:y:2022:i:c:s0022053121000181

DOI: 10.1016/j.jet.2021.105201

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