Strategic Informed Trading and the Value of Private Information

ArXiv ID: 2404.08757 “View on arXiv”

Authors: Unknown

Abstract

We consider a market of risky financial assets whose participants are an informed trader, a representative uninformed trader, and noisy liquidity providers. We prove the existence of a market-clearing equilibrium when the insider internalizes her power to impact prices, but the uninformed trader takes prices as given. Compared to the associated competitive economy, in equilibrium the insider strategically reveals a noisier signal, and prices are less reactive to publicly available information. Additionally, and in direct contrast to the related literature, in equilibrium the insider’s indirect utility monotonically increases in the signal precision. Therefore, the insider is motivated not only to obtain, but also to refine, her signal. Lastly, we show that compared to the competitive economy, the insider’s internalization of price impact is utility improving for the uninformed trader, but somewhat surprisingly may be utility decreasing for the insider herself. This utility reduction occurs provided the insider is sufficiently risk averse compared to the uninformed trader, and provided the signal is of sufficiently low quality.

Keywords: Market Microstructure, Insider Trading, Information Asymmetry, Price Impact, Equities

Complexity vs Empirical Score

• Math Complexity: 8.5/10
• Empirical Rigor: 2.0/10
• Quadrant: Lab Rats
• Why: The paper is heavily mathematical, featuring analytical proofs, derivations of equilibrium conditions via cubic equations, and comparative statics in a CARA-normal framework, earning a high math complexity score. However, it is purely theoretical with no backtesting, data analysis, or implementation details, resulting in low empirical rigor.

  flowchart TD
    A["Research Goal<br>Study strategic informed trading<br>with price impact internalization"] --> B["Model Setup"]
    
    B --> C{"Market Participants<br>and Assets"}
    C --> D["Informed Trader<br>Strategic, Risk-Averse"]
    C --> E["Uninformed Trader<br>Price-Taker, Competitive"]
    C --> F["Noisy Liquidity Providers<br>Supply noise"]
    
    B --> G["Key Methodology<br>Equilibrium Analysis"]
    G --> H["Signal Structure<br>Private signal + public info"]
    G --> I["Price Formation<br>Clearing condition internalized"]
    
    D --> J["Computational Process<br>Solve Equilibrium"]
    E --> J
    F --> J
    H --> J
    I --> J
    
    J --> K["Key Findings"]
    
    K --> L["Equilibrium Outcomes"]
    L --> M["Signal revelation is noisier"]
    L --> N["Prices less reactive to public info"]
    
    K --> O["Insider Utility Properties"]
    O --> P["Utility increases in signal precision<br>Rationale for refining signals"]
    O --> Q["Utility may decrease vs. competitive<br>When risk-averse & low quality signal"]
    
    K --> R["Welfare Implications"]
    R --> S["Uninformed trader utility improves"]
    R --> T["Price impact internalization benefit"]