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Essays on information asymmetry and microstructure of equity markets

Malay K Dey, University of Massachusetts Amherst


Research in market microstructure attempts to determine how differences among trading systems affect price formation in financial markets. In this dissertation, I investigate how large order sizes, and discrete order time/short selling constraints may affect price formation in an equity market. I model a trading system where there are three types of traders, pure information, pure liquidity, and information-liquidity traders. Information-liquidity traders use both private information regarding future value of securities and their liquidity needs to determine their trades. The information liquidity traders are institutions that frequently trade large blocks, and are not subject to short selling constraints. First, a one-shot game is developed as in Easley and O'Hara (1987) with three types of traders and multiple order sizes. Derived results from the model confirm observed price effect of block trades in general, and particularly of large order size on thinly traded stocks. Second, I derive a mixed model in which the arrival of each type of trader is assumed to be a poisson process with time-invariant parameters as in Easley, Kiefer, O'Hara, and Paperman (1996). I outline an MLE method to empirically estimate the parameters of the theoretical model in the first essay. Further using TORQ data, I provide empirical results confirming the role of institutional trading as a determinant of bid ask spread. Finally, I outline a repeated game with two kinds of shocks—private and public information shocks. Some agents receive both shocks, while others receive only a public information shock. I call them complete and incomplete information traders respectively. If there are conflicting signals from the two information sources a fraction of the complete information traders who do not have short selling constraints short sell; others do not trade at all. In this model several rounds of trades occur following a set of shocks. I follow the general framework of Easley and O'Hara (1992) and Diamond and Verecchhia (1987) to show that order time and short sell prohibitions have different price effects in bull (buy > sell) and bear (sell > buy) markets. In a bull market, adverse private information is readily impounded into prices.

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Recommended Citation

Dey, Malay K, "Essays on information asymmetry and microstructure of equity markets" (2001). Doctoral Dissertations Available from Proquest. AAI3001148.