A Baseline Model of Price Formation in a Sequential Market

Abstract

A basic question in economics is how well the market price aggregates and transmits dispersed information. We address this using the trading protocol of Glosten and Milgrom (1985) but in an environment where there are neither pure liquidity-driven traders, nor pure speculators. We prove that the ask and bid prices in the limit collapse to a single value (the limiting price) that reveals the fundamental value of the asset. Adverse selection does not impede the estimation problem in the sense that the rate of convergence to the limiting price is the same as that of a fully signal-revealing mechanism.