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Multidimensional noise and non-fundamental information diversity

David Russ

The North American Journal of Economics and Finance, 2022, vol. 59, issue C

Abstract: This paper relaxes the common assumption of the standard competitive noisy rational expectations framework that noise is one-dimensional. Within an environment characterized by multidimensional noise, I explore the strategic interactions between different traders that are informed about different components of the noise inherent in the market price. If noise is two-dimensional, several new types of complementarities in traders’ interactions arise that cannot be studied in the classical one-dimensional framework. The higher-dimensional case uncovers that higher dimensionality of noise mitigates the possibility of a market breakdown by weakening adverse selection. On the basis of the theoretical results, I discuss some predictions and implications concerning the effects of the increased usage of “payment for order flow” in financial markets.

Keywords: Adverse selection; Noise trading; Non-fundamental information; Payment for order flow (search for similar items in EconPapers)
JEL-codes: C62 D53 G12 G40 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1016/j.najef.2021.101593

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