The Value of Waiting to Trade

To capture trader heterogeneity in a market microstructure setting, we model a trader’s option to trade as an optimal stopping problem. This option to trade is much like a firm’s option to invest in the real options literature. The optimal bid-ask prices quoted by any trader are functions of the joint evolution of their own private value and the private value of their intended trading counterparty. We find that there is a component of the bid-ask spread which can be ascribed to the value of waiting to trade; this component is a product of heterogeneous private values for the traded asset. Further, we calculate the probability of trade in this setting, and find that trade is more likely to take place with those with which you often, but not always, agree on asset valuation, rather than those with which you almost always disagree. This demonstrates that trader heterogeneity can limit, rather than stimulate, trade. JEL Classification: G10, G12, G13.