Man or machine? Rational trading without information about fundamentals

Stefano Rossi and Katrin Tinn

No 9958, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We present a model of quantitative trading as an automated system under human supervision. Contrary to previous literature we show that price-contingent trading is the profitable equilibrium strategy of large rational agents in efficient markets. The key ingredient is uncertainty about whether a large trader is informed about fundamentals. Even when uninformed, he still learns more from prices than market participants who still wonder about whether he is informed. Therefore, he will trade a non-zero quantity based on past prices, whose direction ? trend-following or contrarian ? depends on parameters. When informed, he will trade on that information and disregard the algorithm. One implication is that future order flow is predictable even if markets are semi-strong efficient by construction.

Keywords: Kyle model; Log-concavity; Rational expectations; Rational price-contingent trading (search for similar items in EconPapers)
JEL-codes: D82 G12 G14 (search for similar items in EconPapers)
Date: 2014-05
New Economics Papers: this item is included in nep-mst
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Citations: View citations in EconPapers (1)

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Working Paper: Man or Machine? Rational trading without information about fundamentals (2012)
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