Bid–Ask Price Competition with Asymmetric Information between Market-Makers |
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Authors: | RICCARDO CALCAGNO STEFANO LOVO |
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Affiliation: | Vrije Universiteit Amsterdam; HEC School of Management, Finance and Economics Department, and GREGHEC |
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Abstract: | This paper studies the effect of asymmetric information on the price formation process in a quote-driven market. One market-maker receives private information on the value of the quoted asset and repeatedly competes with market-makers who are uninformed. We show that despite the fact that the informed market-maker's quotes are public, the market is never strong-form efficient with certainty until the last stage. We characterize a reputational equilibrium in which the informed market-maker influences and possibly misleads the uninformed market-makers' beliefs. At this equilibrium, a price leadership effect arises, the informed market-maker's expected pay-off is positive and the rate of price discovery increases in the last stages of trade. |
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