Continuous Auctions and Insider Trading
About: This article is published in Econometrica.The article was published on 1985-11-01. It has received 9341 citations till now. The article focuses on the topics: Common value auction & Electronic trading.
Citations
More filters
TL;DR: In this article, the authors present a simple overlapping generations model of an asset market in which irrational noise traders with erroneous stochastic beliefs both affect prices and earn higher expected returns.
Abstract: We present a simple overlapping generations model of an asset market in which irrational noise traders with erroneous stochastic beliefs both affect prices and earn higher expected returns. The unpredictability of noise traders' beliefs creates a risk in the price of the asset that deters rational arbitrageurs from aggressively betting against them. As a result, prices can diverge significantly from fundamental values even in the absence of fundamental risk. Moreover, bearing a disproportionate amount of risk that they themselves create enables noise traders to earn a higher expected return than rational investors do. The model sheds light on a number of financial anomalies, including the excess volatility of asset prices, the mean reversion of stock returns, the underpricing of closed-end mutual funds, and the Mehra-Prescott equity premium puzzle.
5,703 citations
TL;DR: In this article, the authors show that expected market illiquidity positively affects ex ante stock excess return, suggesting that expected stock ex ante excess return partly represents an illiquid price premium, which complements the cross-sectional positive return-illiquidity relationship.
5,636 citations
TL;DR: In this paper, the effects of stock illiquidity on stock return have been investigated and it was shown that expected market illiquidities positively affects ex ante stock excess return (usually called risk premium) over time.
Abstract: New tests are presented on the effects of stock illiquidity on stock return. Over time, expected market illiquidity positively affects ex ante stock excess return (usually called â¬Srisk premiumâ¬?). This complements the positive cross-sectional return-illiquidity relationship. The illiquidity measure here is the average daily ratio of absolute stock return to dollar volume, which is easily obtained from daily stock data for long time series in most stock markets. Illiquidity affects more strongly small firms stocks, suggesting an explanation for the changes â¬Ssmall firm effectâ¬? over time. The impact of market illiquidity on stock excess return suggests the existence of illiquidity premium and helps explain the equity premium puzzle.
5,333 citations
Cites background or result from "Continuous Auctions and Insider Tra..."
...Kyle (1985) proposed that because market makers cannot distinguish between order flow that is generated by informed traders and by liquidity (noise) traders, they set prices that are an increasing function of the imbalance in the order flow which may indicate informed trading....
[...]
...This is consistent with the illiquidity explanation of the small firm effect since illiquidity costs are increasing in the asymmetry of information between traders (see Glosten and Milgrom, 1985; Kyle, 1985 )....
[...]
TL;DR: The authors proposed a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors' confidence as a function of their investment outcomes.
Abstract: We propose a theory of securities market under- and overreactions based on two well-known psychological biases: investor overconfidence about the precision of private information; and biased self-attribution, which causes asymmetric shifts in investors’ confidence as a function of their investment outcomes. We show that overconfidence implies negative long-lag autocorrelations, excess volatility, and, when managerial actions are correlated with stock mispricing, public-event-based return predictability. Biased self-attribution adds positive short-lag autocorrelations ~“momentum”!, short-run earnings “drift,” but negative correlation between future returns and long-term past stock market and accounting performance. The theory also offers several untested implications and implications for corporate financial policy. IN RECENT YEARS A BODY OF evidence on security returns has presented a sharp challenge to the traditional view that securities are rationally priced to ref lect all publicly available information. Some of the more pervasive anomalies can be classified as follows ~Appendix A cites the relevant literature!: 1. Event-based return predictability ~public-event-date average stock returns of the same sign as average subsequent long-run abnormal performance! 2. Short-term momentum ~positive short-term autocorrelation of stock returns, for individual stocks and the market as a whole!
4,007 citations
Posted Content•
TL;DR: In this article, the authors provide a model that links an asset's market liquidity and traders' funding liquidity, i.e., the ease with which they can obtain funding, to explain the empirically documented features that market liquidity can suddenly dry up, has commonality across securities, is related to volatility, is subject to flight to quality, and comoves with the market.
Abstract: We provide a model that links an asset's market liquidity - i.e., the ease with which it is traded - and traders' funding liquidity - i.e., the ease with which they can obtain funding. Traders provide market liquidity, and their ability to do so depends on their availability of funding. Conversely, traders' funding, i.e., their capital and the margins they are charged, depend on the assets' market liquidity. We show that, under certain conditions, margins are destabilizing and market liquidity and funding liquidity are mutually reinforcing, leading to liquidity spirals. The model explains the empirically documented features that market liquidity (i) can suddenly dry up, (ii) has commonality across securities, (iii) is related to volatility, (iv) is subject to “flight to quality¶, and (v) comoves with the market, and it provides new testable predictions. Keywords: Liquidity Risk Management, Liquidity, Liquidation, Systemic Risk, Leverage, Margins, Haircuts, Value-at-Risk, Counterparty Credit Risk
3,638 citations
Cites background from "Continuous Auctions and Insider Tra..."
...A bank’s capital W consists of equity capital plus its long-term borrowings (including credit lines secured from individual or syndicates of commercial banks), reduced by assets that cannot be readily employed (e.g. goodwill, intangible assets, property, equipment, and capital needed for daily…...
[...]
...…a security can be costly to trade — that is, has less than perfect market liquidity — because of exogenous order processing costs, private information (Kyle (1985) and Glosten and Milgrom (1985)), inventory risk of market makers (e.g. Stoll (1978), Ho and Stoll (1981,1983) Ho and Stoll (1981) and…...
[...]
References
More filters
TL;DR: The presence of traders with superior information leads to a positive bid-ask spread even when the specialist is risk-neutral and makes zero expected profits as discussed by the authors, and the expectation of the average spread squared times volume is bounded by a number that is independent of insider activity.
5,902 citations
"Continuous Auctions and Insider Tra..." refers result in this paper
...Furthermore, our emphasis on the dynamic optimizing behavior of the insider distinguishes our model from the one of Glosten and Milgrom [3]....
[...]
01 Jan 1984
223 citations
"Continuous Auctions and Insider Tra..." refers background in this paper
...Kyle [5], however, discusses a model of imperfect competition among market makers, in which many insiders with different information participate....
[...]