Robust Price Formation
48 Pages Posted: 19 Mar 2012 Last revised: 1 Apr 2015
Date Written: April 1, 2015
Abstract
We analyze security price formation in a dynamic setting in which long-lived dealers repeatedly compete for trading with short-lived retail traders. We characterize equilibria in which dealers’ dynamic pricing strategies are optimal no matter the private information each dealer may possess. Thus, our model’s predictions are robust to different specifications of dealers’ information structure. These equilibria reconcile in a single and parsimonious model price dynamics that are reminiscent of well-known stylized facts: excess price volatility, price/trading-flow correlation, stochastic volatility and inventory-related trading.
Keywords: financial market microstructure, belief-free equilibria, informed market makers, price volatility
JEL Classification: G1, G12, C72, C73
Suggested Citation: Suggested Citation
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