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Insider Trading, Stochastic Liquidity, and Equilibrium Prices
Author(s) -
CollinDufresne Pierre,
Fos Vyacheslav
Publication year - 2016
Publication title -
econometrica
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 16.7
H-Index - 199
eISSN - 1468-0262
pISSN - 0012-9682
DOI - 10.3982/ecta10789
Subject(s) - market liquidity , economics , insider trading , stochastic volatility , volatility (finance) , price formation , pairs trade , mean reversion , econometrics , financial economics , algorithmic trading , insider , monetary economics , alternative trading system , finance , political science , law
We extend Kyle's (1985) model of insider trading to the case where noise trading volatility follows a general stochastic process. We determine conditions under which, in equilibrium, price impact and price volatility are both stochastic, driven by shocks to uninformed volume even though the fundamental value is constant. The volatility of price volatility appears ‘excessive’ because insiders choose to trade more aggressively (and thus more information is revealed) when uninformed volume is higher and price impact is lower. This generates a positive relation between price volatility and trading volume, giving rise to an endogenous subordinate stochastic process for prices.