Journal Article

Bid-Ask Price Competition with Asymmetric Information between Market-Makers

Riccardo Calcagno and Stefano Lovo

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 73, issue 2, pages 329-355
Published in print April 2006 | ISSN: 0034-6527
Published online April 2006 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2006.378_1.x
Bid-Ask Price Competition with Asymmetric Information between Market-Makers

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  • Information, Knowledge, and Uncertainy
  • Economics
  • International Finance

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This paper studies the effect of asymmetric information on the price formation process in a quote-driven market. One market-maker receives private information on the value of the quoted asset and repeatedly competes with market-makers who are uninformed. We show that despite the fact that the informed market-maker's quotes are public, the market is never strong-form efficient with certainty until the last stage. We characterize a reputational equilibrium in which the informed market-maker influences and possibly misleads the uninformed market-makers' beliefs. At this equilibrium, a price leadership effect arises, the informed market-maker's expected pay-off is positive and the rate of price discovery increases in the last stages of trade.

Keywords: D82; F31; G14

Journal Article.  14246 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy ; Economics ; International Finance

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