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Belief-free Price Formation

Johannes Hörner and Stefano Lovo

No 17-790, TSE Working Papers from Toulouse School of Economics (TSE)

Abstract: We analyze security price formation in a dynamic setting in which long-lived dealers repeatedly compete for trading with potentially informed retail traders. For a class of market microstructure models, we characterize equilibria in which dealers’ dynamic pricing strategies are optimal no matter the private information each dealer may possess. In a generalized version of the Glosten and Milgrom model, these equilibria deliver price dynamics reminiscent of well-known stylized facts: price/trading-flow correlation, volatility clustering, price bubble and inventory/inter-dealer trading correlation.

Keywords: Financial Market Microstructure; Belief-free Equilibria; Informed Market Makers; Price Volatility (search for similar items in EconPapers)
JEL-codes: C72 C73 G1 G12 (search for similar items in EconPapers)
Date: 2017-03
New Economics Papers: this item is included in nep-mst
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