Risk aversion, informative noise trading, and long-lived information

Deqing Zhou and Fang Zhen

Economic Modelling, 2021, vol. 97, issue C, 247-254

Abstract: We build a dynamic strategic trading model in which noise trading demand may be correlated with an asset's fundamental value. This correlation shapes the temporal properties of a perfect Bayesian equilibrium. The more positive the correlation coefficient, the faster prices incorporate private information. In contrast, when the correlation is negative and only one risk-neutral insider exists, an abundant amount of private information cannot be revealed after the final trade, and market liquidity deteriorates over time. Moreover, information is revealed faster during earlier periods if positively correlated noise demand is concentrated early, whereas more information remains hidden after the final trade if negatively correlated noise demand is concentrated later. The inefficiency caused by negatively correlated noise demand can be resolved if insiders are competitive or risk averse.

Keywords: Informative noise trading; Risk aversion; Price efficiency (search for similar items in EconPapers)
JEL-codes: C72 D82 G14 (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:97:y:2021:i:c:p:247-254

DOI: 10.1016/j.econmod.2021.02.001

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