Divergent Behavior in Markets with Idiosyncratic Private Information

Abstract

A state of perpetually evolving divergent trading strategies is the natural consequence of a market with idiosyncratic private information. In the face of intrinsic uncertainty about other traders' strategies, participants resort to learning and adaptation to identify and exploit profitable trading opportunities. Model-consistent use of market-based information generally improves price performance but can inadvertently produce episodes of sudden mis-pricing. The paper examines the impact of trader's use of information and bounded rationality on price efficiency.