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Belief-free price formation

Johannes Hörner, Stefano Lovo and Tristan Tomala

Journal of Financial Economics, 2018, vol. 127, issue 2, 342-365

Abstract: We analyze security price formation in a dynamic setting in which long-lived dealers repeatedly compete for the opportunity to trade with short-lived retail traders. We characterize equilibria in which dealers’ pricing strategies are optimal irrespective of the private information that each dealer may possess. Thus, our model’s predictions are robust to different specifications of the dealers’ information structure. These equilibria reconcile, in a unified and parsimonious framework, price dynamics that are reminiscent of well-known stylized facts: excess price volatility, price to trading flow correlation, stochastic volatility and inventory-related trading.

Keywords: Financial market microstructure; Informed dealers; Price volatility; Belief-free equilibria (search for similar items in EconPapers)
JEL-codes: G1 G12 C72 C73 (search for similar items in EconPapers)
Date: 2018
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:127:y:2018:i:2:p:342-365

DOI: 10.1016/j.jfineco.2017.11.004

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