Information and strategic behavior

Abstract

Does encouraging trader participation enhance market competitiveness? This paper shows that, when trader preferences are interdependent, trader market power does not necessarily decrease with greater participation, and traders need not become price takers in large markets. Thus, larger markets can be less liquid and associated with lower ex ante welfare. In the linear-normal model, the necessary and sufficient condition on the information structure is provided under which price impact is monotone in market size. A condition is given when the rational expectations equilibrium, which is typically not fully revealing within the considered class of preference interdependencies, is obtained in large markets.

Information, Coordination, and Market Frictions: An Introduction

“…In fact, Vives [124,125] shows that the price impact is of the order of 1/n and that the deadweight loss converges to zero at the same rate. The paper by Rostek and Weretka [102] shows that, with heterogeneous correlation in valuations, the above results need not hold. To start with, the equilibrium is not typically privately revealing (it is so only if the heterogeneity in correlations among values is absent for all trader pairs).…”

“…The fourth paper in the symposium by Rostek and Weretka [102] addresses the question of whether encouraging trader participation enhances market competitiveness and liquidity. The answer is in the negative when traders' preferences are interdependent: larger markets can be less liquid and associated with lower ex-ante welfare.…”

Welfare Consequences of Information Aggregation and Optimal Market Size

“…5 When negative externalities exist, this limit may not be the ideal benchmark. Rostek and Weretka (2014) present a model in which welfare can be lower in a larger market, because the preference interdependence can change with the market size in a way that increases traders'market power. We present our main result assuming that traders are price-takers.…”

“…. By investigating (20) and (22), we characterize how (k; '; n') depens on n. Importantly, k = 1 if t = w = 1, but otherwise k increases in n.…”

“…The key di¤erence from the symmetric information case is that as n increases prices reveal more information to traders. 22 In fact, Welfare analysis.…”