Information-Based Trading

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Bouzianis, G; Hughston, L P and Sánchez-Betancourt, L. 2024. Information-Based Trading. International Journal of Theoretical and Applied Finance, 27(3,4), 2350030. ISSN 0219-0249 [Article]

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Official URL: https://www.worldscientific.com/doi/10.1142/S02190...

Abstract or Description

We consider a pair of traders in a market where the information available to the second trader is a strict subset of the information available to the first trader. The traders make prices based on information concerning a security that pays a random cash flow at a fixed time T in the future. Market information is modelled in line with the scheme of Brody, Hughston & Macrina (2007, 2008, 2011) and Brody, Davis, Friedman & Hughston (2009). The risk-neutral distribution of the cash flow is known to the traders, who make prices with a fixed multiplicative bid-offer spread and report their prices to a game master who declares that a trade has been made when the bid price of one of the traders crosses the offer price of the other. We prove that the value of the first trader’s position is strictly greater than that of the second. The results are analyzed by use of simulation studies and generalized to situations where (a) there is a hierarchy of traders, (b) there are multiple successive trades, and (c) there is inventory aversion.

Item Type:

Article

Identification Number (DOI):

https://doi.org/10.1142/S0219024923500309

Additional Information:

Electronic version of an article published in the International Journal of Theoretical and Applied Finance https://doi.org/10.1142/S0219024923500309

Keywords:

Information-based asset pricing, information processes, trading models, informed traders, Brownian bridge, nonlinear filtering, signal to noise ratio, bid-offer spread, inventory aversion

Departments, Centres and Research Units:

Computing

Dates: