Equilibrium Pricing and Trading Volume under Preference Uncertainty

Bruno Biais, Johan Hombert and Pierre-Olivier Weill

No 787, IDEI Working Papers from Institut d'Économie Industrielle (IDEI), Toulouse

Abstract: Information collection, processing and dissemination financial institutions is challenging. This can delay the observation by traders of the exact capital charges and constraints of their institution. During this delay, traders face preference uncertainty. In this context, we study optimal trading strategies and equilibrium prices in a continuous centralized market. We focus on liquidity shocks, during which preference uncertainty is likely to matter most. Preference uncertainty generates allocative ineficiency, but need not reduce prices. Traders progressively learning about the preferences of their institution conduct round-trip trades, which generate excess volume relative to the frictionless market. In a cross section of liquidity shocks, the initial price drop is positively correlated with total trading volume. Across traders, the number of round-trips is negatively correlated with trading profits and average inventory.

JEL-codes: D8 G1 (search for similar items in EconPapers)
Date: 2013-07, Revised 2013-12
New Economics Papers: this item is included in nep-mic, nep-mst and nep-upt
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Related works:
Journal Article: Equilibrium Pricing and Trading Volume under Preference Uncertainty (2014)
Working Paper: Equilibrium Pricing and Trading Volume under Preference Uncertainty (2014)
Working Paper: Equilibrium Pricing and Trading Volume under Preference Uncertainty (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:ide:wpaper:27434

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