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Giffen Goods and Market Making

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  • Giovanni Cespa

Abstract

This paper shows that information effects per se are not responsible for the Giffen goods anomaly affecting traders' demands in multi asset noisy, rational expectations equilibrium markets. The role that information plays in traders' strategies also matters. In a market with risk averse, uninformed traders, informed agents have a dual trading motive: speculation and market making. The former entails using prices to assess the effect of error terms; the latter requires employing them to disentangle noise traders' demands within aggregate orders. In a correlated environment this complicates the signal extraction problem and may generate upward sloping demand curves. Assuming (i) that competitive, risk neutral market makers price the assets or that (ii) uninformed traders' risk tolerance coefficient grows unboundedly, removes the market making component from informed traders' demands rendering them well behaved in prices.

Suggested Citation

  • Giovanni Cespa, 2003. "Giffen Goods and Market Making," Working Papers 68, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:68
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    References listed on IDEAS

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    1. Bhattacharya Utpal & Reny Philip J. & Spiegel Matthew, 1995. "Destructive Interference in an Imperfectly Competitive Multi-Security Market," Journal of Economic Theory, Elsevier, vol. 65(1), pages 136-170, February.
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    Cited by:

    1. Giovanni Cespa, 2004. "A Comparison of Stock Market Mechanisms," RAND Journal of Economics, The RAND Corporation, vol. 35(4), pages 803-824, Winter.
    2. Giovanni Cespa & Xavier Vives, 2015. "The Beauty Contest and Short-Term Trading," Journal of Finance, American Finance Association, vol. 70(5), pages 2099-2154, October.
    3. Vives, Xavier & Cespa, Giovanni, 2011. "Expectations, Liquidity, and Short-term Trading," CEPR Discussion Papers 8303, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    Giffen goods; financial economics; Asset pricing; information; market efficiency;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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