Market Efficiency and Price Formation When Dealers are Asymmetrically Informed

R. Calcagno, S.M. Lovo

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We consider the effect of asymmetric information on the price formation process in a quote-driven market where one market maker receives a private signal on the security fundamental.A model is presented where market makers repeatedly compete in prices: at each stage a bid-ask auction occurs and the winner trades the security against liquidity traders.We show that at equilibrium the market is not strong-form efficient until the last stage.We characterize a reputational equilibrium in which the informed market maker will affect market beliefs, and possibly misleads them.At this equilibrium, a price leadership effect arises, quotes are never equal to the expected value of the asset given the public information, the informed market maker expected payoff is positive and the rate of price discovery increases in the last stages of trade before the information becomes public.
Original languageEnglish
Place of PublicationTilburg
Publication statusPublished - 2002

Publication series

NameCentER Discussion Paper


  • pricing
  • information
  • market structure
  • capital markets


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