Insider trading, stochastic liquidity and equilibrium prices

We extend Kyle’s (1985) model of insider trading to the case where liquidity provided by noise traders follows a general stochastic process. Even though the level of noise trading volatility is observable, in equilibrium, measured price impact is stochastic. If noise trading volatility is mean-reverting, then the equilibrium price follows a multivariate `stochastic bridge’ process, which displays stochastic volatility. This is because insiders choose to optimally wait to trade more aggressively when noise trading activity is higher. In equilibrium, market makers anticipate this, and adjust prices accordingly.More private information is revealed when volatility is higher. In time series, insiders trade more aggressively, when measured price impact is lower. Therefore, execution costs to uninformed traders can be higher when price impact is lower.

Netspar, Network for Studies on Pensions, Aging and Retirement, is a thinktank and knowledge network. Netspar is dedicated to promoting a wider understanding of the economic and social implications of pensions, aging and retirement in the Netherlands and Europe.

MORE ABOUT NETSPAR


Mission en strategy           •           Network           •           Organisation           •          Magazine
Board Brief            •            Actionplan 2023-2027           •           Researchagenda

ABOUT NETSPAR

Our partners

vu
NN_logo_gray
B20190901_nidi-logo_greyscale
B20160708_apg
B20160708_ministeries
View all partners