Order Time, Multiple Shocks, and Short Selling in Security Price Adjustment

Abstract

We investigate if order time and short selling have any bearing on how prices are formed and adjusted towards full information value in the securities market. We model a competitive dealership market in which complete and incomplete information traders arrive in a probabilistic fashion to trade a single risky security for cash with a market maker. The complete information traders receive a private information about the future value of a security and a signal from a public information release indicating a buy or a sell. The incomplete information traders trade for liquidity on the basis of the public information signal. Derived results from the model suggest that while buy or sell reveals private information, although asymmetrically, no-trade may provide information about the signal from public information depending on whether the market is optimistic (high buy) or pessimistic (high sell) market. Security prices adjust to their full information value at a faster rate when short selling constraints are low. The speed and the nature of adjustment of security prices differ if the market is optimistic vs. pessimistic. In an optimistic market adverse private information is instantaneously impounded into prices.

Keywords: Information asymmetry, securities pricing, sequential game

JEL Classification: G10, G14