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Stock market insider trading in continuous time with imperfect dynamic information

By Albina Danilova

Abstract

In this paper, I study the equilibrium pricing of asset shares in the presence of dynamic private information. The market consists of a risk-neutral informed agent who observes the firm value, noise traders and competitive market makers who set share prices using the total order flow as a noisy signal of the insider's information. I provide a characterization of all optimal strategies and prove the existence of both Markovian and non-Markovian equilibria by deriving closed-form solutions for the optimal order process of the informed trader and the optimal pricing rule of the market maker. The consideration of non-Markovian equilibrium is relevant since the market maker might decide to re-weight past information after receiving a new signal. Also, I show that (1) there is a unique Markovian equilibrium price process that allows the insider to trade undetected and (2) the presence of an insider increases the market's informational efficiency, in particular, for times close to dividend payment

Topics: HG Finance, QA Mathematics, HA Statistics
Publisher: Taylor & Francis
Year: 2010
DOI identifier: 10.1080/17442500903106614
OAI identifier: oai:eprints.lse.ac.uk:29004
Provided by: LSE Research Online
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