Strategic trading and learning about liquidity
نویسندگان
چکیده
Many practitioners point out that the speculative profits of institutional traders are eroded by the difficulty in gauging the price impact of their trades. In this paper, we develop a model of strategic trading where speculators face such a dilemma because of incomplete information about time-varying market liquidity. Unlike the competitive market makers that they trade against, informed traders do not know the distribution of liquidity (‘‘noise’’) trades. Instead, they have to learn about liquidity from past prices and trading volume. This learning implies that strategic trades and market statistics such as informational efficiency are path-dependent on past market outcomes. Our paper also has normative implications for practitioners. r 2002 Elsevier Science B.V. All rights reserved. JEL classification: G10; G14
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