Limit orders,asymmetric information,and the formation of asset prices with a computerized specialist |
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| Authors: | Michael R Baye Ann Gillette Casper G de Vries |
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| Institution: | (1) Present address: Department of Economics, The Pennsylvania State University, 16802-3305 University Park, PA, USA;(2) Present address: School of Business, Indiana University, 801 West Michigan Street, 46202-5151 Indianapolis, IN, USA;(3) Present address: Tinbergen Institute, Erasmus Universiteit Rotterdam, Oostmaaslaan 950, 3063 DM Rotterdam, The Netherlands |
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| Abstract: | We analyze the existence of equilibrium in an asset market under asymmetric information. Price formation is modeled as a bilateral sealed bid auction where uninformed and informed traders submit limit orders to a computerized specialist. The computerized specialist is programmed to sell to the highest bidder and buy from the seller asking the lowest price. We show that this mechanism — which is designed to model the Globex and RAES trading institutions used in Chicago, London, New York, Paris, and Germany — yields an equilibrium in which the bid-ask spread is endogenously random and the passive specialist earns nonnegative profits. |
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