Strategic Trading And Learning About Liquidity

Sven Rady and Harrison Hong

No 2416, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We develop a multi-period model of strategic trading in an asset market where traders are uncertain about market liquidity. In our model, informed traders strategically trade against competitive market makers to exploit their short-lived private information. Unlike market makers, informed traders do not know whether the liquidity ('noise') trades are generated from a distribution with high or low variance. Instead, informed traders have to learn about liquidity from past prices. We find the following. (1) Prices that deviate markedly from the forecast of terminal asset value based on public news tend to lead to revisions of informed traders' beliefs in favour of the low liquidity state. (2) This revision in beliefs results in less aggressive trading on private information by informed traders. (3) In turn, informational efficiency and trading volume are dependent on the path of prices. (4) Moreover, learning about liquidity also has interesting effects on the unconditional properties of optimal strategic trading policies.

Keywords: Bayesian learning; Liquidity uncertainty; Private information; Strategic trading (search for similar items in EconPapers)
JEL-codes: D40 D83 G12 G14 (search for similar items in EconPapers)
Date: 2000-04
References: Add references at CitEc
Citations:

Downloads: (external link)
https://cepr.org/publications/DP2416 (application/pdf)

Related works:
Journal Article: Strategic trading and learning about liquidity (2002)
Working Paper: Strategic Trading and Learning about Liquidity (2001)
Working Paper: Strategic Trading and Learning about Liquidity (2000)
Working Paper: Strategic trading and learning about liquidity (2000)
Working Paper: Strategic Trading and Learning About Liquidity (2000)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:2416

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP2416

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().