Abstract
We analyze the professionals’ strategies of information production and the consequent market efficiency in the presence of discretionary liquidity trading. A unique equilibrium exists where only parts of discretionary liquidity traders can satisfy their liquidity needs. Instead of competition effect, strategic complementary effect occurs with the production of information by professionals. In particular, with discretionary liquidity trading, increases in the compensation of discretionary liquidity traders and/or the number of professionals promote information production and enhance market liquidity and information efficiency, although price volatility is amplified. This result suggests that regulators should open more access to information production for better market efficiency.
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