Journal ArticleDOI
The Trader's Dilemma: Trading Strategies and Endogenous Pricing in an Illiquid Market
Dan Liang,Frank Milne +1 more
TLDR
In this article, the authors investigate a large trader's trading strategies in a decentralized market, in which all traders are subject to type switching and derive subgame perfect equilibria under three different spot market structures.Abstract:
We investigate a large trader's trading strategies in a decentralized market, in which all traders are subject to type switching. The large trader has pressure to liquidate her position by the end of the horizon to avoid extra holding costs. She faces a trade-off: if she trades quickly, she moves the price too much; if she trades slowly, she may not be able to find counterparties in the market in later periods. We derive subgame perfect equilibria under three different spot market structures. The structures are chosen to show various degrees of competitive bargaining. We show that in each equilibrium the large trader chooses the optimal trading strategy to take into account both the price impact effect and liquidity uncertainty. Thus asset prices are generated endogenously through a dynamic bargaining and trading process and reflect the impact of the large trader's trades. Small traders, who possess little market power, cannot be ignored because their reactions to the large trader's trading strategy jointly determines market liquidity. We show that limiting competitive pricing occurs when there are enough small traders, or there are many trading periods. Illiquidity is generated by the thin market for buyers, and their limited capacity to buy the asset sold by the large trader.read more
Citations
More filters
Posted Content
Market Manipulation, Bubbles, Corners, and Short Squeezes
TL;DR: In this article, the authors investigated market manipulation trading strategies by large traders in the stock market and provided sufficient conditions for their nonexistence under a reasonable hypothesis on the equilibrium price process.
Posted Content
Strategic trading in a dynamic noisy market
TL;DR: In this article, a dynamic model of a financial market with a strategic trader was studied, where the strategic trader receives a privately observed endowment in the stock market and trades with competitive market makers to share risk.
Journal ArticleDOI
Distressed Sales and Financial Arbitrageurs: Front-running in Illiquid Markets ∗
TL;DR: In this paper, the authors investigate the impact of an arbitrageur's activities in an illiquid market, where there is a large distressed trader and a fringe of small traders, and they find that equilibrium strategies for large traders vary with their relative bargaining power and the level of uncertainty with respect to market liquidity.
References
More filters
Journal ArticleDOI
Search and endogenous concentration of liquidity in asset markets
Dimitri Vayanos,Tan Wang +1 more
TL;DR: In this paper, the authors develop a search-based model of asset trading, in which investors of different horizons can invest in two assets with identical payoffs, and show the existence of a "clientele" equilibrium where all short-horizon investors search for the same asset.
Journal ArticleDOI
Liquidity shocks and equilibrium liquidity premia
TL;DR: An equilibrium in which agents face surprise liquidity shocks and invest in liquid and illiquid riskless assets is studied to help understand why some securities have high liquidity premia, despite low turnover frequency.
Posted Content
Over-the-Counter Markets
Darrell Duffie,Darrell Duffie,Nicolae Gârleanu,Nicolae Gârleanu,Nicolae Gârleanu,Lasse Heje Pedersen +5 more
TL;DR: In this article, the authors study how intermediation and asset prices in over-the-counter markets are affected by illiquidity associated with search and bargaining, and compute explicitly the prices at which investors trade with each other as well as marketmakers' bid and ask prices in a dynamic model with strategic agents.
Journal ArticleDOI
Equilibrium interest rate and liquidity premium with transaction costs
Dimitri Vayanos,Jean-Luc Vila +1 more
TL;DR: In this article, the effects of transaction costs on asset prices were studied in an overlapping generations economy with two riskless assets. And they showed that agents buy the liquid asset for short-term investment and the illiquid asset for longterm investment.
Journal ArticleDOI
Strategic trading in a dynamic noisy market
TL;DR: In this paper, a dynamic model of a financial market with a strategic trader was studied, where the strategic trader receives a privately observed endowment in the stock market and trades with competitive market makers to share risk.