Bluffing: an Equilibrium Strategy

The present work studies the behavior of a monopolistic informed trader in a two-period competitive dealer market. We show that the informed trader may engage in stock price manipulation as a result of the exploitation of his informational advantage (su±cient conditions are provided). The informed trader achieves this manipulation by not trading in the ̄rst period according to the information received. This trader attempts to jam his signal or to blu®. In equilibrium this behavior is anticipated by the market maker, but still the informed continues to blu® with a positive probability. Equilibria with blu±ng behavior are mixed strategies equilibria where the informed both follows and jams his information with positive probabilities. We also show that under those su±cient conditions, a pure strategy equilibrium where the informed does not blu® does not exist.