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Robust pricing under strategic trading

Author

Listed:
  • Gong, Aibo
  • Ke, Shaowei
  • Qiu, Yawen
  • Shen, Rui

Abstract

We study strategic trading with a market maker who does not know the joint distribution of public information and an asset's value, and hence cannot interpret information properly. Following a public event, a probabilistically informed trader who knows the distribution and liquidity traders trade. The market maker adopts a robust linear pricing strategy that has the best worst-case payoff guarantee. We show that such a strategy is equivalent to a two-step learning procedure, and characterize the unique linear equilibrium. Expected equilibrium prices exhibit underreaction to public information. If the trading frequency is arbitrarily high, the market maker fully reveals the distribution in the price eventually.

Suggested Citation

  • Gong, Aibo & Ke, Shaowei & Qiu, Yawen & Shen, Rui, 2022. "Robust pricing under strategic trading," Journal of Economic Theory, Elsevier, vol. 199(C).
    • Handle: RePEc:eee:jetheo:v:199:y:2022:i:c:s0022053121000181
    DOI: 10.1016/j.jet.2021.105201
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    More about this item

    Keywords

    Robust pricing; Strategic trading; Ambiguity; Underreaction to public information;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G00 - Financial Economics - - General - - - General
    • G40 - Financial Economics - - Behavioral Finance - - - General

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