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Belief-free Price Formation

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  • Hörner, Johannes
  • Lovo, Stefano

Abstract

We analyze security price formation in a dynamic setting in which long-lived dealers repeatedly compete for trading with potentially informed retail traders. For a class of market microstructure models, we characterize equilibria in which dealers’ dynamic pricing strategies are optimal no matter the private information each dealer may possess. In a generalized version of the Glosten and Milgrom model, these equilibria deliver price dynamics reminiscent of well-known stylized facts: price/trading-flow correlation, volatility clustering, price bubble and inventory/inter-dealer trading correlation.

Suggested Citation

  • Hörner, Johannes & Lovo, Stefano, 2017. "Belief-free Price Formation," TSE Working Papers 17-790, Toulouse School of Economics (TSE).
    • Handle: RePEc:tse:wpaper:31598
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    More about this item

    Keywords

    Financial Market Microstructure; Belief-free Equilibria; Informed Market Makers; Price Volatility;
    All these keywords.

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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