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Communication Dilemma in Speculative Markets

Nevzat Eren and Han Ozsoylev

No 2006-FE-08, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: We study voluntary information exchange widely observed among traders in financial markets. In the context of a standard market microstructure model, based on Kyle (1984, 1985), we show that disparately informed traders are better off by exchanging information provided that they are risk averse and the market is opaque. For some parameter values, the equilibrium yields a prisoners` dilemma result in which traders hoard information even though it is beneficial for them to exchange. In the presence of interpersonal costs, which penalize those who hoard information when others disclose, information exchange can be sustained as an equilibrium outcome. Repeated interactions can also sustain, in equilibrium, information exchange.

Date: 2006-03-01
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