Trading Motives in Asset Markets

Wang, Zijian (2019): Trading Motives in Asset Markets.

Abstract

I study how trading motives in asset markets affect equilibrium outcomes and welfare. I focus on two types of trading motives -- informational and allocational. I show that while a fully separating equilibrium is the unique equilibrium when trading motives are known, multiple equilibria exist when trading motives are unknown. Moreover, forcing traders to reveal their trading motives may harm welfare. I also use this model to study how an asset market may exit a fire sale equilibrium and how government programs may eliminate private information and improve agents' welfare.

• Item Type: MPRA Paper
• Language: English
• Keywords: Asset markets, private information, competitive search, government intervention
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G18 - Government Policy and Regulation

References

Andolfatto, D. (2010). On the social cost of transparency in monetary economies. Working Paper, Federal Reserve Bank of St. Louis.

Andolfatto, D., A. Berentsen, and C. Waller (2014). Optimal disclosure policy and undue diligence. Journal of Economic Theory 149, 128–152.

Bajaj, A. (2018). Undefeated equilibria of the shi-trejos-wright model under adverse selection. Journal of Economic Theory 176 (7), 957–986.

Chang, B. (2018). Adverse selection and liquidity distortion. The Review of Economic Studies 85 (1), 275–306.

Cho, I.-K. and D. M. Kreps (1987). Signaling games and stable equilibria. The Quarterly Journal of Economics 102 (2), 179–221.

Dang, T. V., G. Gorton, B. Holmstr¨om, and G. Ordonez (2017). Banks as secret keepers. American Economic Review 107 (4), 1005–29.

Duffie, D. (2011). Dark markets: Asset pricing and information transmission in over-the-counter markets. Princeton University Press.

Faig, M. and B. Jerez (2006). Inflation, prices, and information in competitive search. Advances in Macroeconomics 6 (1), 1–34.

Geromichalos, A. and L. Herrenbrueck (2016). Monetary policy, asset prices, and liquidity in over-the-counter markets. Journal of Money, Credit and Banking 48 (1), 35–79.

Geromichalos, A. and L. Herrenbrueck (2018a). The liquidity-augmented model of macroeconomic aggregates. Working Paper, Simon Fraser University.

Geromichalos, A. and L. Herrenbrueck (2018b). The strategic determination of the supply of liquid assets. Working Paper, University of California, Davis.

Geromichalos, A., L. Herrenbrueck, and S. Lee (2018). Asset safety vs asset liquidity. Working Paper, University of California, Davis.

Geromichalos, A., L. Herrenbrueck, and K. Salyer (2016). A search-theoretic model of the term premium. Theoretical Economics 11 (3), 897–935.

Guerrieri, V. and R. Shimer (2014). Dynamic adverse selection: A theory of illiquidity, fire sales, and flight to quality. American Economic Review 104 (7), 1875–1908.

Guerrieri, V. and R. Shimer (2018). Markets with multidimensional private information. American Economic Journal: Microeconomics 10 (2), 250–74.

Guerrieri, V., R. Shimer, and R.Wright (2010). Adverse selection in competitive search equilibrium. Econometrica 78 (6), 1823–1862.

Herrenbrueck, L. (2019). Frictional asset markets and the liquidity channel of monetary policy. Journal of Economic Theory. Forthcoming.

Herrenbrueck, L. and A. Geromichalos (2017). A tractable model of indirect asset liquidity. Journal of Economic Theory 168, 252–260.

Madison, F. (2018). Frictional asset reallocation under adverse selection. Journal of Economic Dynamics and Control. Forthcoming.

Mailath, G. J., M. Okuno-Fujiwara, and A. Postlewaite (1993). Belief-based refinements in signalling games. Journal of Economic Theory 60 (2), 241–276.

Nosal, E. and N. Wallace (2007). A model of (the threat of) counterfeiting. Journal of Monetary Economics 54 (4), 994–1001.

Riley, J. G. (2001). Silver signals: Twenty-five years of screening and signaling. Journal of Economic literature 39 (2), 432–478.

Rocheteau, G. (2008). Money and competing assets under private information. Working paper.

Rocheteau, G. (2011). Payments and liquidity under adverse selection. Journal of Monetary Economics 58 (3), 191–205.

Vayanos, D. (2001). Strategic trading in a dynamic noisy market. The Journal of Finance 56 (1), 131–171.

Williams, B. (2016). Search, liquidity, and retention: signaling multidimensional private information. In 2016 Meeting Papers, Number 1413. Society for Economic Dynamics.

Yoon, J. H. (2017). Endogenous market structure: Over-the-counter versus exchange trading. Working Paper, University of Wisconsin-Madison.