Abstract
We study a generalization of Kyle’s (1985) model to the case in which the specialist is risk-averse and does not set the transaction price according to semi-strong form efficiency. We see that Kyle’s call auction market is no longer a robust market structure, as linear Bayesian equilibria do not exist, irrespective of fundamentals, such as agents’ information, endowments and preferences. This result holds both when customers can submit only market orders and when limit orders are allowed too.
Highlights
In auction markets, such as the NYSE, specialists fix transaction prices after customers have filed their orders
We study a generalization of Kyle’s (1985) model to the case in which the specialist is risk-averse and does not set the transaction price according to semi-strong form efficiency
In Pete Kyle’s formulation of a call auction market [1], these agents represent passive agents who set transaction prices according to semi-strong efficiency condition
Summary
In auction markets, such as the NYSE, specialists fix transaction prices after customers have filed their orders. In Pete Kyle’s formulation of a call auction market [1], these agents represent passive agents who set transaction prices according to semi-strong efficiency condition In this way it is possible to identify linear equilibria and study the characteristics of the market. We show that when specialists are risk-averse the simple linear equilibria of Kyle’s analysis disappear This holds irrespective of preferences and endowments of market participants or of the degree of informational asymmetry among the specialists and the informed traders. It is the consequence of the particular protocol of trading imposed by Kyle’s framework, where specialists act after their customers. To outline the fragility of such framework is important given the ample attention it has received in the literature
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