Information Acquisition in a Limit Order Market
Christine Parlour
Haas School of Business
University of California, Berkeley
Wednesday, February 22, 2006
4:30 - 5:45 PM
Terman Engineering Center, Room 453
Abstract:
We model endogenous information acquisition in a limit order market
for a single financial asset. The asset has a common value; in
addition, each trader has a private value for it. Traders randomly
arrive at the market, after choosing whether to purchase information
about the common value. They may either post prices or accept posted
prices. If a trader's order has not executed, he randomly reenters the
market, and may change his previous order. The model is thus a dynamic
stochastic game with asymmetric information. We numerically solve for
the equilibrium of the trading game, and characterize equilibria with
endogenous information acquisition. Over a range of information
acquisition costs, the game can exhibit a prisoner's dilemma -- all
agents, including those who acquire information, are worse off. Agents
with the lowest intrinsic benefit from trade have the highest value
for information and also tend to supply liquidity.
As a result, market observables such as bid and ask quotes, in
addition to transaction prices, are informative about the common value
of the asset. Adverse selection is important for individuals (agents
have lower payoffs when uninformed), but in the aggregate it has
little effect on investor surplus, unless gains to trade are
small. Comparisons to a frictionless benchmark show that the limit
order market is effective at consummating trade and generating
consumer surplus, even in the presence of asymmetric
information.
Joint work with Uday Rajan and Ron Goettler.
Operations Research Colloquia: http://or.stanford.edu/oras_seminars.html