Price impact under heterogeneous beliefs and restricted participation

Michail Anthropelos and Constantinos Kardaras

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We consider a financial market in which traders potentially face restrictions in trading some of the available securities. Traders are heterogeneous with respect to their beliefs and risk profiles, and the market is assumed thin: traders strategically trade against their price impacts. We prove existence and uniqueness of a corresponding equilibrium, and provide an efficient algorithm to numerically obtain the equilibrium prices and allocations given market's inputs. We find that restrictions may increase the market's welfare if traders have different views regarding the covariance matrix of securities returns. The latter heterogeneity regarding covariance matrix disagreement is essential in modelling; for instance, when traders agree on the covariance matrix, restricting participation in some securities for some traders leaves equilibrium prices unaltered in the unrestricted securities, a certainly undesirable model effect.

Keywords: thin markets; restricted participation; constrained participation; price impact; risk sharing; Nash equilibrium; heterogeneous beliefs; disagreement on second moments; welfare (search for similar items in EconPapers)
JEL-codes: J1 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2024-01-01
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Published in Journal of Economic Theory, 1, January, 2024, 215. ISSN: 0022-0531

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