The Beauty Contest and Short-Term Trading

Cespa, Giovanni; Vives, Xavier

doi:10.2139/ssrn.2697645

Cited by 20 publications

(23 citation statements)

References 81 publications

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“…Fourth, by highlighting the first order asset pricing impact of uninformed traders' imbalance predictability, this paper shares some features of our previous work (Cespa and Vives (2012), and Cespa and Vives (2015)). In that setup, however, predictability obtained because of the assumed statistical properties of noise traders' demands, whereas in this paper it arises endogenously, because of a participation friction.…”

Section: Introductionsupporting

confidence: 56%

“…This paper is related to four strands of the literature. First, equilibrium multiplicity, complementarities, and liquidity fragility are phenomena known to obtain in economies where asset prices are driven by fundamentals information and noise trading (see, e.g., Cespa and Foucault (2014), Cespa and Vives (2015), Goldstein et al (2014), and Goldstein and Yang (2015)). In this setup, in contrast, asset prices are exclusively driven by non-fundamentals information.…”

Section: Introductionmentioning

confidence: 99%

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High Frequency Trading and Fragility

Cespa

Vives

2016

SSRN Journal

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may No 2020 / February 2017 AbstractWe show that limited dealer participation in the market, coupled with an informational friction resulting from high frequency trading, can induce demand for liquidity to be upward sloping and strategic complementarities in traders' liquidity consumption decisions: traders demand more liquidity when the market becomes less liquid, which in turn makes the market more illiquid, fostering the initial demand hike. This can generate market instability, where an initial dearth of liquidity degenerates into a liquidity rout (as in a flash crash). While in a transparent market, liquidity is increasing in the proportion of high frequency traders, in an opaque market strategic complementarities can make liquidity U-shaped in this proportion as well as in the degree of transparency. These episodes seem to have in common the fact that illiquidity brings more illiquidity, contrary to the dynamic that in normal market conditions illiquidity, by moderating the demand for immediacy, produces a self-stabilizing effect. In a crash, in contrast, an increase in illiquidity fosters a disorderly "run for the exit," accentuating the price movement.In the paper we trace this source of fragility to the fact that modern markets' pervasive presence of automated trading hampers market participants' access to (i) trade, and (ii) quote information. That is, two frictions shape trading activity nowadays: a participation friction (not all liquidity suppliers are continuously present in the market), and an informational friction (not all traders have access to timely market information).We model these two computerized-trading related frictions in a two-period dynamic noisy rational expectations model. We consider risk-averse dealers who provide liquidity to two cohorts of risk-averse, short-term traders who receive a common endowment shock. Dealers can be "full", with a continuous market presence as stylized high frequency traders (HFTs), or only be present in the first period market. In the first round of trade both dealers' types absorb the (market) orders of the first traders' cohort. In the second trading round, only full dealers participate. Full dealers can therefore accommodate the reverting orders of the first traders' cohort, as well as those of the incoming second cohort who only observe an imperfect signal about the first period order imbalance.We show that dealers' limited market participation favors the ...

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Section: Introductionsupporting

confidence: 56%

Section: Introductionmentioning

confidence: 99%

High Frequency Trading and Fragility

Cespa

Vives

2016

SSRN Journal

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“…The idea of a two-way feedback between trading activity and market informativeness is also present in Cespa and Vives (2015). They study a two period market in the tradition of noisy rational expectations literature and find that multiple equilibria can arise when noise-trader shocks are sufficiently persistent and informed buyers care only about their short-term returns.…”

Section: Related Literaturementioning

confidence: 99%

Information Spillovers in Asset Markets with Correlated Values

2015

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We study the effect of information spillovers and transparency in a dynamic setting with adverse selection and correlated asset values. A trade (or lack thereof) by one seller can provide information about the quality of other assets in the market. In equilibrium, the information content of this trading behavior is endogenously determined. We show that this endogeneity of information leads to multiple equilibria when the correlation between asset values is sufficiently high. That is, if buyers expect "bad" assets to trade quickly, then a seller with a bad asset has reason to be concerned about negative information being revealed, which induces her to trade quickly. Conversely, if buyers do not expect bad assets to trade quickly, then the seller has less to be concerned about and is more willing to wait. We study the implications for policies that target market transparency.We show that total welfare is higher when markets are fully transparent than when the market is fully opaque. However, both welfare and trading activity can decrease in the degree of market transparency. * Affiliation: CREi, Universitat Pompeu Fabra, and Barcelona GSE.

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“…only the equilibrium with the smaller η is stable in the sense of the following definition, akin to that of Cespa and Vives (2015).…”

Section: Equilibriummentioning

confidence: 99%

Delegated portfolio management, optimal fee contracts, and asset prices

Sato

2016

Journal of Economic Theory

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This paper proposes a model of asset-market equilibrium with portfolio delegation and optimal fee contracts. Fund managers and investors strategically interact to determine funds' investment profiles, while they share portfolio risk through fee contracts. In equilibrium, their investment decisions, fee schedules, and stock price feed back into one another. The model predicts that (1) stock market's expected return and volatility increase as more investor capital is intermediated by funds, (2) fund's expense ratio is stable despite volatile market, (3) aggregate fund flow is positively (inversely) related to subsequent (past) market return, and (4) funds provide investors with a volatility hedge by adjusting market exposure countercyclically.

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The Beauty Contest and Short-Term Trading

Cited by 20 publications

References 81 publications

High Frequency Trading and Fragility

High Frequency Trading and Fragility

Information Spillovers in Asset Markets with Correlated Values

Delegated portfolio management, optimal fee contracts, and asset prices

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