Siraprapa Watakit 5502310013

Overview and Contribution Theoretical Background and Model Conclusion

Overview The paper develop a theory around trading patterns which arises as a result of informed trader and strategic liquidity trader. The results provide some empirical explanation about trading patterns of volume and price variability. Contribution New models which accounted for strategic behavior of liquidity trader

Typical observation: Trading patterns of a day a U shape. Trading volume is intense at the beginning and end of the day,

Such empirical finding leads to the following question Why does trading tend to be concentrated in particular time? Why are returns more variable in some periods and less variable in others? Why do the periods of higher trading volume also tend to be the periods of higher return variability? To answer these question, we had better look at the trader behaviors
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Traders

Informed Traders Liquidity

No strategies With Strategies

Big assumption Previous studies assumed that all un-informed or liquidity trader are just noises e.g. ordinary or individual trader This is a too big assumption if we consider that large financial institutions are also, many times, considered as liquidity traders , whose trades reflects client liquidity needs Minimizing transaction costs is obviously in order
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Developing models: Based on Glosten Milgrom(1985) and *Kyle(1984,1985) Market maker: Risk neutral, setting prices based on aggregated flows Traders: informed traders act on private information non-discretionary traders just trade, no timing model discretionary traders trade with strategic timing model

Model of informed traders The trading time is divided into T period F is value of asset, t is mean zero i.i.d. random variable of public information In each period t, there assumed to be nt trader who observe private information at t+1+t where var(t)=t If informed traders received noisy signal at t, the information will be public at the beginning of t+1 Assumed that informed trader will act on it at t+1. ( This is a oneperiod model, no linkage between period, information is shortlived), he needs to decide how much to trade Order flows of informed traders is

Model of non-discretionary trader He needs to trade immediately, with a specific amount at 1 period (no split trade) Order flows of non-discretionary trader is Model of discretionary trader He needs not to trade immediately but he must trade before the end of day, so he choose carefully when to trade. He can also split trade Suppose there is m discretionary traders, order flows is Hence, all aggregated order flows from all 3 traders type is
= Note that variance of uninformed order, , affects the equilibrium price
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The market maker determine the price from aggregated order flow

Where is a Kyle market depth parameter(price impact from order flows) Notice that market maker strategy include both public and private information in his model Main result in this section: for discretionary trader, there are tendency that they will trade in the same period.

Given that market maker follow the pricing rule, optimal strategies for informed trader and discretionary trader can be determined X depends on no. of other informed, nt variance of order, variance of private info. is decreasing in nt , . Since (total variance of uninformed trader) is endogenous, the strategic behavior of discretionary trader affect the prices This is a significant departure from a passive role as in other studies
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For discretionary traders In Admati and Pfleiderer model, discretionary traders are assumed to take as given. If it werent, there will be many and many equillibrium since every action will affect Hence, the problem is reduced to justchoose to transact at the lowest cost period offered by market maker That lowest cost period is the one with highest It follows that, all discretionary traders will select the same period to transactinducing price patterns Since the optimal strategy for informed traders depends on , the informed trader patterns will follow discretionary patterns as well
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The model take strategic behavior of discretionary un-informed trader into account which results in the following findings discretionary trader chooses the optimal time to transact his action affect the total variance of uninformed trade, Market maker price rules depend on aggregated order flow which is also depends on , Since discretionary trader takes as given, all discretuinary trader will transact at the lowest cost periodinducing patterns discretionary trader pattern will causes informed trader pattern as well

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