The goal of this paper written by Albert S. Kyle is to answer question that are important for capital market users. First question in the paper is asking how much time is needed for the private information to be put in the market, in other words how when the market will reflect the price change. Next question relates to insider trader and his valuation of private information and how volatility is affected by noise trading. Last question asks what define liquidity of a speculative market. In order to answer these questions author comes up with model showing interactions between three participants on the market, a single risk neutral trader, random noise traders, and competitive risk neutral market makers.
From the methodology side Kyle develop the model in which he incorporates three market participants. The risk neutral insider trader benefit from the access to private information of the risky asset’s value when it is liquidated. He also takes into account the quantities and prices he traded in the past, but he does not obtain quantities and prices from the future. In the asset market he act as monopolist and maximize his expected profit. The noise traders trade random quantities, which are independent with respect to the past trades. The market makers uses information about other market participants trades and sets the prices. While doing so market makers cannot dedifferentiate between insider and noise trader, thus they earn on average zero profit. In the model there is one risky asset exchanged for a riskless asset between our three kinds of participants. Trading is placed in different auctions and each of them is divided into two steps. Firstly the insider and noise trader at same time choose their quantity. In the next phase market maker as a third participant trades a specific quantity that clears the market. The model has linear structure and the random variables are normally distributed. Firstly model presents one step trading by single auction...
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