INFORMATION-BASED TRADING

George Bouzianis, Lane P. Hughston () and Leandro Sã Nchez-Betancourt
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George Bouzianis: Department of Computing, Goldsmiths University of London, New Cross, London SE14 6NW, UK
Lane P. Hughston: Department of Computing, Goldsmiths University of London, New Cross, London SE14 6NW, UK
Leandro Sã Nchez-Betancourt: Mathematical Institute, University of Oxford, Woodstock Road, Oxford OX2 6GG, UK3Oxford-Man Institute of Quantitative Finance, Walton Well Road, Oxford OX2 6ED, UK

International Journal of Theoretical and Applied Finance (IJTAF), 2024, vol. 27, issue 03n04, 1-33

Abstract: We consider a pair of traders in a market where the information available to the second trader is a strict subset of the information available to the first trader. The traders make prices based on information concerning a security that pays a random cash flow at a fixed time T in the future. Market information is modeled in line with the scheme of Brody, Hughston, and Macrina. The risk-neutral distribution of the cash flow is known to the traders, who make prices with a fixed multiplicative bid-offer spread and report their prices to a game master who declares that a trade has been made when the bid price of one of the traders crosses the offer price of the other. We prove that the value of the first trader’s position is strictly greater than that of the second. The results are analyzed by use of simulation studies and generalized to situations where (a) there is a hierarchy of traders, (b) there are multiple successive trades, and (c) there is inventory aversion. In these settings, we show that information is superior to strategy.

Keywords: Information-based asset pricing; information processes; trading models; informed traders; Brownian bridge; nonlinear filtering; signal to noise ratio; bid-offer spread; inventory aversion (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1142/S0219024923500309

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