Equilibrium Pricing and Trading Volume under Preference Uncertainty

Bruno Biais, Johan Hombert and Pierre-Olivier Weill
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Johan Hombert: GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique

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Abstract: Information collection and processing in financial institutions is challenging. This can delay the observation by traders of the exact capital charges and constraints of their institution. During this delay, traders face preference uncertainty. In this context, we study optimal trading strategies and equilibrium prices in a continuous centralized market. We focus on liquidity shocks, during which preference uncertainty is likely to matter most. Preference uncertainty generates allocative inefficiency, but need not reduce prices. Progressively learning about preferences generate round–trip trades, which increase volume relative to the frictionless market. In a cross section of liquidity shocks, the initial price drop is positively correlated with total trading volume. Across traders, the number of round–trips is negatively correlated with trading profits and average inventory.

Keywords: Information processing; Trading volume; Liquidity shock; Preference uncertainty; Equilibrium pricing (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (14)

Published in Review of Economic Studies, 2014, 81 (4), pp.1401-1437. ⟨10.1093/restud/rdu008⟩

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Related works:
Journal Article: Equilibrium Pricing and Trading Volume under Preference Uncertainty (2014)
Working Paper: Equilibrium Pricing and Trading Volume under Preference Uncertainty (2013)
Working Paper: Equilibrium Pricing and Trading Volume under Preference Uncertainty (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-01097584

DOI: 10.1093/restud/rdu008

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