Market Efficiency and Price Formation When Dealers are Asymmetrically Informed

R. Calcagno, S.M. Lovo

Research output: Working paperDiscussion paperOther research output

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Abstract

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
PublisherFinance
Volume2002-42
Publication statusPublished - 2002

Publication series

NameCentER Discussion Paper
Volume2002-42

Fingerprint

Price formation
Market efficiency
Market makers
Market price
Dealers
Public information
Traders
Asymmetric information
Bid
Price discovery
Auctions
Price leadership
Expected value
Liquidity
Assets

Keywords

  • pricing
  • information
  • market structure
  • capital markets

Cite this

Calcagno, R., & Lovo, S. M. (2002). Market Efficiency and Price Formation When Dealers are Asymmetrically Informed. (CentER Discussion Paper; Vol. 2002-42). Tilburg: Finance.
Calcagno, R. ; Lovo, S.M. / Market Efficiency and Price Formation When Dealers are Asymmetrically Informed. Tilburg : Finance, 2002. (CentER Discussion Paper).
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Calcagno, R & Lovo, SM 2002 'Market Efficiency and Price Formation When Dealers are Asymmetrically Informed' CentER Discussion Paper, vol. 2002-42, Finance, Tilburg.

Market Efficiency and Price Formation When Dealers are Asymmetrically Informed. / Calcagno, R.; Lovo, S.M.

Tilburg : Finance, 2002. (CentER Discussion Paper; Vol. 2002-42).

Research output: Working paperDiscussion paperOther research output

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Calcagno R, Lovo SM. Market Efficiency and Price Formation When Dealers are Asymmetrically Informed. Tilburg: Finance. 2002. (CentER Discussion Paper).