Robust Price Formation

48 Pages Posted: 19 Mar 2012 Last revised: 1 Apr 2015

See all articles by Johannes Horner

Johannes Horner

Yale University - Cowles Foundation

Stefano Lovo

HEC Paris - Finance Department

Tristan Tomala

HEC Paris - Economics & Decision Sciences

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

Horner, Johannes and Lovo, Stefano and Tomala, Tristan, Robust Price Formation (April 1, 2015). Available at SSRN: https://ssrn.com/abstract=2024311 or http://dx.doi.org/10.2139/ssrn.2024311

Johannes Horner

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States

Stefano Lovo (Contact Author)

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

Tristan Tomala

HEC Paris - Economics & Decision Sciences ( email )

1 rue de la Liberation
Paris, 78351
France

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