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Risk aversion, informative noise trading, and long-lived information

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  • Zhou, Deqing
  • Zhen, Fang

Abstract

We build a dynamic strategic trading model in which noise trading demand may be correlated with an asset's fundamental value. This correlation shapes the temporal properties of a perfect Bayesian equilibrium. The more positive the correlation coefficient, the faster prices incorporate private information. In contrast, when the correlation is negative and only one risk-neutral insider exists, an abundant amount of private information cannot be revealed after the final trade, and market liquidity deteriorates over time. Moreover, information is revealed faster during earlier periods if positively correlated noise demand is concentrated early, whereas more information remains hidden after the final trade if negatively correlated noise demand is concentrated later. The inefficiency caused by negatively correlated noise demand can be resolved if insiders are competitive or risk averse.

Suggested Citation

  • Zhou, Deqing & Zhen, Fang, 2021. "Risk aversion, informative noise trading, and long-lived information," Economic Modelling, Elsevier, vol. 97(C), pages 247-254.
    • Handle: RePEc:eee:ecmode:v:97:y:2021:i:c:p:247-254
    DOI: 10.1016/j.econmod.2021.02.001
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    References listed on IDEAS

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    More about this item

    Keywords

    Informative noise trading; Risk aversion; Price efficiency;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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