Seminar

Belief-free Price Formation

Stefano Lovo (HEC Paris)

April 8, 2013, 12:30–14:00

Room MF 323

Fédération des Banques Françaises Seminar

Abstract

We analyze security price formation in a dynamic setting in which long-lived dealers repeatedly compete for trading with potentially informed retail traders. For a class of market microstructure models, we characterize equilibria in which dealers’ dynamic pricing strategies are optimal no matter the private information each dealer may possess. In a generalized version of the Glosten and Milgrom model, these equilibria deliver price dynamics reminiscent of well-known stylized facts: price/trading-flow correlation, volatility clustering, price bubble and inventory/inter-dealer trading correlation.

Keywords

Financial Market Microstructure; Belief-free Equilibria; Informed Market Makers; Price Volatility;