Articles

Belief-free price formation

J. HÖRNER, S. LOVO, T. TOMALA

Journal of Financial Economics

February 2018, vol. 127, n°2, pp.342-365

Departments: Finance, GREGHEC (CNRS), Economics & Decision Sciences

Keywords: Financial market microstructure, Informed dealers, Price volatility, Belief-free equilibria

https://www.sciencedirect.com/science/article/pii/S0304405X17302921


We analyze security price formation in a dynamic setting in which long-lived dealers re- peatedly compete for the opportunity to trade with short-lived retail traders. We charac- terize equilibria in which dealers’ pricing strategies are optimal irrespective of the private information that each dealer may possess. Thus, our model’s predictions are robust to dif- ferent specifications of the dealers’ information structure. These equilibria reconcile, in a unified and parsimonious framework, price dynamics that are reminiscent of well-known stylized facts: excess price volatility, price to trading flow correlation, stochastic volatility and inventory-related trading


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