An asymmetric information model is introduced for the situation in which there is a small agent who is more susceptible to the flow of information in the market than the general market participant, and who tries to implement strategies based on the additional information. In this model market participants have access to a stream of noisy information concerning the future return of an asset, whe...

This paper studies a dynamic model of a nancial market with a strategic trader. In each period the strategic trader receives a privately observed endowment in the stock. He trades with competitive market makers to share risk. Noise traders are present in the market. After receiving a stock endowment, the strategic trader is shown to reduce his risk exposure either by selling at a decreasing rat...

We argue that arbitrage is limited if rational traders face uncertainty about when their peers will exploit a common arbitrage opportunity. This synchronization risk—which is distinct from noise trader risk and fundamental risk—arises in our model because arbitrageurs become sequentially aware of mispricing and they incur holding costs. We show that rational arbitrageurs ‘‘time the market’’ rat...

Exchange rates differ considerably with respect to exchange rate volatility, while they are very similar with respect to the macroeconomic fundamentals — the well known exchange rate disconnect puzzle. The microeconomic structure of foreign exchange markets, especially the existence of noise traders, may be responsible for the excessive volatility in flexible exchange rate regimes. The entry of...

The behavior of US closed-end funds is very different from that of the UK funds studied by Gemmill and Thomas (2002). There is no evidence that their discounts are constrained by arbitrage barriers, no evidence that higher expenses increase discounts and no evidence that replication risk increases discounts—but strong evidence that noise-trader risk is priced. The differences between US and UK ...

The present paper expands on recent attempts at estimating the parameters of simple interacting-agent models of financial markets [S. Alfarano, T. Lux, F. Wagner, Computational Economics 26, 19 (2005); S. Alfarano, T. Lux, F. Wagner, in Funktionsfähigkeit und Stabilität von Finanzmärkten, edited by W. Franz, H. Ramser, M. Stadler (Mohr Siebeck, Tübingen, 2005), pp. 241–254]. Here we provide add...

We develop a two period model of trade where an insider, a noise trader, a high frequency trader (HFT) and a market maker trade a divisible asset that has a common value in two parallel markets. The market makers set competitive prices in both markets. We analyze the e ects of the high frequency trader, who can gain from observing prices across markets, on market quality. Even though informed t...

We model asset management as a continuum between active and passive: managers can deviate from benchmark indices to exploit noise trader–induced distortions, but agency frictions constrain these deviations. Because constraints force buy assets that they underweight when appreciate, overvalued have high volatility, the risk-return relationship becomes inverted. Distortions are more severe for th...

If f is a risk measure, the diversification benefit of aggregating portfolio’s A and B is defined to be (1) f(A) + f(B)− f(A + B) When using full revaluation VaR as the methodology for computing a risk measure, its quite possible to get negative diversification. Pathological examples are possible, but the following example is not absurd: Suppose one has a portfolio that is made up by a Trader A...

This article constructs an economic model of a rational trader who operates in a market with transaction costs and noise trading. The level of trading affects the rational trader’s marginal cost of transacting; as a result, trading volume (through its effect on marginal cost) is a source of risk. This engenders an equilibrium relationship between returns and volume. The model also provides a si...