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Bid, ask and transaction prices in a specialist market with heterogeneously informed traders
 Journal of Financial Economics
, 1985
"... The presence of traders with superior information leads to a positive bidask spread even when the specialist is riskneutral and makes zero expected profits. The resulting transaction prices convey information, and the expectation of the average spread squared times volume is bounded by a number th ..."
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Cited by 1217 (5 self)
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The presence of traders with superior information leads to a positive bidask spread even when the specialist is riskneutral and makes zero expected profits. The resulting transaction prices convey information, and the expectation of the average spread squared times volume is bounded by a number that is independent of insider activity. The serial correlation of transaction price differences is a function of the proportion of the spread due to adverse selection. A bidask spread implies a divergence between observed returns and realizable returns. Observed returns are approximately realizable returns plus what the uninformed anticipate losing to the insiders. 1.
The PrincipalAgent Relationship with an Informed Principal, II: Common Values
 ECONOMETRICA
, 1992
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Heterogeneous agent models in economics and finance
 IN HANDBOOK OF COMPUTATIONAL ECONOMICS (EDS
, 2005
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A Model of Intertemporal Asset Prices Under Asymmetric Information
, 1993
"... This paper presents a dynamic assetpricing model under asymmetric information. Investors have different information concerning the future growth rate of dividends. They rationally extract information from prices as well as dividends and maximize their expected utility. The model has a closedform s ..."
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Cited by 176 (12 self)
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This paper presents a dynamic assetpricing model under asymmetric information. Investors have different information concerning the future growth rate of dividends. They rationally extract information from prices as well as dividends and maximize their expected utility. The model has a closedform solution to the rational expectations equilibrium. We find that existence of uninformed investors increases the risk premium. Supply shocks can affect the risk premium only under asymmetric information. Information asymmetry among investors can increase price volatility and negative autocorrelation in returns. Lessinformed investors may rztionally behave like price chasers.
Interactive unawareness
 Journal of Economic Theory
, 2006
"... The standard statespaces of asymmetric information preclude nontrivial forms of unawareness (Modica and Rustichini, 1994, Dekel, Lipman and Rustichini, 1998). We introduce a generalized statespace model that allows for nontrivial unawareness among several individuals, and which satisfies strong ..."
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Cited by 91 (12 self)
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The standard statespaces of asymmetric information preclude nontrivial forms of unawareness (Modica and Rustichini, 1994, Dekel, Lipman and Rustichini, 1998). We introduce a generalized statespace model that allows for nontrivial unawareness among several individuals, and which satisfies strong properties of knowledge as well as all the desiderata on unawareness proposed this far in the literature.
How markets slowly digest changes in supply and demand
, 2008
"... In this article we revisit the classic problem of tatonnement in price formation from a microstructure point of view, reviewing a recent body of theoretical and empirical work explaining how fluctuations in supply and demand are slowly incorporated into prices. Because revealed market liquidity is ..."
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Cited by 81 (11 self)
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In this article we revisit the classic problem of tatonnement in price formation from a microstructure point of view, reviewing a recent body of theoretical and empirical work explaining how fluctuations in supply and demand are slowly incorporated into prices. Because revealed market liquidity is extremely low, large orders to buy or sell can only be traded incrementally, over periods of time as long as months. As a result order flow is a highly persistent longmemory process. Maintaining compatibility with market efficiency has profound consequences on price formation, on the dynamics of liquidity, and on the nature of impact. We review a body of theory that makes detailed quantitative predictions about the volume and time dependence of market impact, the bidask spread, order book dynamics, and volatility. Comparisons to data yield some encouraging successes. This framework suggests a novel interpretation of financial information, in which agents are at best only weakly informed and all have a similar and extremely noisy impact on prices. Most of the processed information appears to come from supply and demand itself, rather than from
Presidential Address: Discount Rates
 Journal of Finance
, 2011
"... Discountrate variation is the central organizing question of current assetpricing research. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with variation in pricedividend ratios due to variation in expected cashflows. Now it seems all pricedividend ..."
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Cited by 71 (1 self)
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Discountrate variation is the central organizing question of current assetpricing research. I survey facts, theories, and applications. Previously, we thought returns were unpredictable, with variation in pricedividend ratios due to variation in expected cashflows. Now it seems all pricedividend variation corresponds to discountrate variation. We also thought that the crosssection of expected returns came from the CAPM. Now we have a zoo of new factors. I categorize discountrate theories based on central ingredients and data sources. Incorporating discountrate variation affects finance applications, including portfolio theory, accounting, cost of capital, capital structure, compensation, and macroeconomics. ASSET PRICES SHOULD EQUAL expected discounted cashflows. Forty years ago, Eugene Fama (1970) argued that the expected part, “testing market efficiency,” provided the framework for organizing assetpricing research in that era. I argue that the “discounted ” part better organizes our research today. I start with facts: how discount rates vary over time and across assets. I turn
A utility framework for boundedloss market makers
 In Proceedings of the 23rd Conference on Uncertainty in Artificial Intelligence
, 2007
"... We introduce a class of utilitybased market makers that always accept orders at their riskneutral prices. We derive necessary and sufficient conditions for such market makers to have bounded loss. We prove that hyperbolic absolute risk aversion utility market makers are equivalent to weighted pseu ..."
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Cited by 70 (26 self)
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We introduce a class of utilitybased market makers that always accept orders at their riskneutral prices. We derive necessary and sufficient conditions for such market makers to have bounded loss. We prove that hyperbolic absolute risk aversion utility market makers are equivalent to weighted pseudospherical scoring rule market makers. In particular, Hanson’s logarithmic scoring rule market maker corresponds to a negative exponential utility market maker in our framework. We describe a third equivalent formulation based on maintaining a cost function that seems most natural for implementation purposes, and we illustrate how to translate among the three equivalent formulations. We examine the tradeoff between the market’s liquidity and the market maker’s worstcase loss. For a fixed bound on worstcase loss, some market makers exhibit greater liquidity near uniform prices and some exhibit greater liquidity near extreme prices, but no market maker can exhibit uniformly greater liquidity in all regimes. For a fixed minimum liquidity level, we give the lower bound of market maker’s worstcase loss under some regularity conditions. 1
Experimental research in financial accounting
 Accounting, Organizations and Society
, 2002
"... This paper uses recent experimental studies of financial accounting to illustrate our view of how such experiments can be conducted successfully. Rather than provide an exhaustive review of the literature, we focus on how particular examples illustrate successful use of experiments to determine how, ..."
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Cited by 55 (0 self)
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This paper uses recent experimental studies of financial accounting to illustrate our view of how such experiments can be conducted successfully. Rather than provide an exhaustive review of the literature, we focus on how particular examples illustrate successful use of experiments to determine how, when and (ultimately) why important features of financial accounting settings influence behavior. We first describe how changes in views of market efficiency, reliance on the experimentalist’s comparative advantage, new theories, and a focus on key institutional features have allowed researchers to overcome the criticisms of earlier financial accounting experiments. We then describe how specific streams of experimental financial accounting research have addressed questions about financial communication between managers, auditors, information intermediaries, and investors, and indicate how future research can extend those streams. We focus particularly on (1) how managers and auditors report information; (2) how users of financial information interpret those reports; (3) how individual decisions affect market behavior; and (4) how strategic interactions between information reporters and users can affect market outcomes. Our examples include and integrate experiments that fall into both the ‘‘behavioral’ ’ and ‘‘experimental economics’ ’ literatures in accounting. Finally, we
Market force, ecology, and evolution
, 2000
"... Markets have internal dynamics leading to excess volatility and other phenomena that are difficult to explain using rational expectations models. This paper studies these using a nonequilibrium price formation rule, developed in the context of trading with market orders. Because this is so much simp ..."
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Cited by 54 (8 self)
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Markets have internal dynamics leading to excess volatility and other phenomena that are difficult to explain using rational expectations models. This paper studies these using a nonequilibrium price formation rule, developed in the context of trading with market orders. Because this is so much simpler than a standard intertemporal equilibrium model, it is possible to study multiperiod markets analytically. There price dynamics have second order oscillatory terms. Value investing does not necessarily cause prices to track values. Trend following causes short term trends in prices, but also causes longerterm oscillations. When value investing and trend following are combined, even though there is little linear structure, there can be boombust cycles, excess and temporally correlated volatility, and fat tails in price fluctuations. The long term evolution of markets can be studied in terms of flows of money. Profits can be decomposed in terms of aggregate pairwise correlations. Under reinvestment of profits this leads to a capital allocation model that is equivalent to a standard model in population