Insider Trading with Temporary Price Impact
We model an informed agent with information about the future value of an asset trying to maximize profits when subjected to a transaction cost as well as a market maker tasked with setting fair transaction prices. In a single auction model, equilibrium is characterized by the unique root of a partic...
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Zusammenfassung: | We model an informed agent with information about the future value of an
asset trying to maximize profits when subjected to a transaction cost as well
as a market maker tasked with setting fair transaction prices. In a single
auction model, equilibrium is characterized by the unique root of a particular
polynomial. Analysis of this polynomial with small levels of risk-aversion and
transaction costs reveal a dimensionless parameter which captures several
orders of asymptotic accuracy of the equilibrium behaviour. In a continuous
time analogue of the single auction model, incorporation of a transaction costs
allows the informed agent's optimal trading strategy to be obtained in feedback
form. Linear equilibrium is characterized by the unique solution to a system of
two ordinary differential equations, of which one is forward in time and one is
backward. When transaction costs are in effect, the price set by the market
maker in equilibrium is not fully revealing of the informed agent's private
signal, leaving an information gap at the end of the trading interval. When
considering vanishing transaction costs, the equilibrium trading strategy and
pricing rules converge to their frictionless counterparts. |
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DOI: | 10.48550/arxiv.2007.14162 |