Rational destabilization in a frictionless market

Tomasz Sadzik and Chris Woolnough

Journal of Economic Theory, 2021, vol. 192, issue C

Abstract: This paper studies the effect of informed trading on prices in a dynamic model with two-dimensional private information. We show that a trader with private information about the asset's value and a persistent liquidity shock trades along with and exacerbates the shock. The price changes more than if the shock was unexpected. When shocks are small, the with-wind trade is so strong that the distribution of prices and asset holdings changes discontinuously from the stabilizing linear equilibrium without them. The results demonstrate strategic price destabilization in a market with no capital or trade frictions.

Keywords: Asymmetric information; Multidimensional signals; Market microstructure; Arbitrage; Front-running (search for similar items in EconPapers)
JEL-codes: D43 D84 G14 (search for similar items in EconPapers)
Date: 2021
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:192:y:2021:i:c:s0022053120301629

DOI: 10.1016/j.jet.2020.105169

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