Inform ationSharing,Liquid ity and T ransac tionCosts
inF loor-B ased T rad ingSystem s.
1
T hierry Fouc ault
HE C and CE P R
1,rue d e la Lib ¶eration
78351 J ouy enJ osas,France.
E m ail:f
ouc ault@hec .f
r
Laurence Lesc ourret
CR E ST and Doc torat HE C
15,B oulevard G ab rielP ¶eri
9 2 2 4 5 M alako®,France.
E mail:lescourr@ensae.f
r
Novemb er,2 0 0 1
1
W e thank G iovanni Cespa, A sani Sarkarand seminarparticipants atCR EST , L avalU ni-
versity, the A FFI20 0 0 conference, the EEA 20 0 0 conference, the FM A 20 0 1 M eetings and the
InternationalFinanceConference T unisie 20 0 1 .A llerrors areours.
Ab strac t
In
f
orm ationSharin
g, Liquid ity an
d T ran
sac tionCostsinF l
oor-B ased T rad ing
System s.
W e c onsid er inf
orm ationsharingb etw eentrad ers(\°oor b rokers") w ho possessd i®erent
typesofinf
ormation,namelyinf
orm ationonthe payo® ofa riskysec urityor inf
ormationon
the volume ofliquid itytrad inginthissec urity.W e interpret these trad ersasd ual-c apac ity
b rokersonthe °oor ofanexc hange.W e id entif
y c onditionsunder w hic h the trad ersare
b etter o® sharing inf
ormation. W e also show that inf
orm ationsharing im proves pric e
d iscovery, red uc esvolatility and low ersexpec ted trad ing c osts. Inf
orm ationsharing c an
im prove or im pair the d epth ofthe m arket, d epend ing onthe valuesofthe param eters.
O verallour analysissuggeststhat inf
orm ationsharing am ong °oor b rokersim provesthe
perf
orm ance of°oor-b ased trad ingsystem s.
K eyw ord s: M arket M ic rostruc ture,F loor-B ased T rad ingSystem s,O penO utc ry,Inf
or-
m ationSharing,Inf
orm ationSales.
J E L Classi¯c ationNumb ers: G 10 ,D82 .
1
In
trod uc tion
T he organiz ationoftrad ing onthe NY SE hasb eenrem arkab ly stab le since its¯rst c on-
stitutionin1817.T rad ingisc onduc ted through openoutc ry ofb id sand o®ersofb rokers
ac tingonb ehalfoftheir c lientsor f
or their ow nac c ount.
1
T histrad ingm echanism isnot
unique to the NY SE .E quity m arketslike the Frankf
urt Stoc k E xc hange and the AM E X
or d erivativesm arketslike the CB O T and the CB O E are °oor m arkets.
2
How ever °oor-
b ased trad ing m ec hanism sare endangered spec iesasthey are progressively replac ed b y
f
ully autom ated trad ing system s
3
. G iventhistrend tow ard autom ation, it isnaturalto
ask w hether °oor-b ased trad ing system sc anprovid e greater liquid ity and low er exec u-
tionc oststhanautomated trad ingsystem s.T hisquestionisofparam ount importance f
or
m arket organizersand trad ers. Inf
ac t, it hasb eenhotly d eb ated b etw eenmemb ersof
E xc hangesw ho c onsid ered sw itc hingf
rom °oor to elec tronic trad ing
4
.Inord er to survive
°oor-b ased trad ing m ec hanism smust outperf
orm autom ated trad ing system salong som e
d imensions.
Autom ated trad ing system sd ominate °oor-b ased trad ing systems inm any respec ts.
F irst °oor m arketsare more expensive to operate (see Dom ow itz and Steil(19 99 )).Sec -
ond physic alspac e lim itsthe numb er ofpartic ipantsin°oor marketsb ut not inautomated
trad ingsystem s.F inally trad ersw ithout anac c essto the °oor are at aninf
orm ationald is-
ad vantage c om pared w ith the trad ersonthe °oor.T hisd isad vantage islikelyto exac erb ate
agency prob lem sb etw eeninvestorsand their b rokers(Sarkar and W u (199 9)).
B y d esign, °oor-b ased marketsf
oster person-to-personc ontac ts. Hence the ab ility of
m arket partic ipantsto share inf
ormationisgreater inthese markets.T hisf
eature isof
ten
view ed asb eingone ad vantage,ifnot the unique one,of°oor-b ased trad ingsystem s.
5
For
instance Harris(2 0 0 0 ),p.8,pointsout that
1
O fcourse,many tradingrules have been changed since the creation ofthe N Y SE.B utithas always
beena° oormarket.SeeH asbrouck,So¯anos andSosebee(1 993)foradetaileddescriptionofthetrading
rules on the N Y SE.
2
In Frankfurt,the° ooroperates in parallelwith an electronictradingsystem.
3
T heM arch¶
eµ
aT ermeInternationaldeFrance(M A T IF),theT orontoStockExchangeandT heL ondon
InternationalFinancialFutures and O ptions Exchange (L IFFE)shutdown their° oorin 1 997,1 998 and
20 0 0 ,respectively.
4
See the Economist(July 31 st1 999):\A home grown revolutionary"and the Economist(A ugust26th
20 0 0 ):\ O utofthepits".
5
Covaland Shumway (1 998)show thatthe levelofnoise on the ° oorofCB O T '
s 30 yearT reasury
B ond futures a®ects price volatility.T his alsosuggests thatperson toperson contacts on the ° oorhave
an impacton priceformation.
1
`F loor-based trad ingsystem sd om inate elec tronic trad ingsystemsw henbrokers
need to exc hange inf
ormationabout their c lientsto arrange their trad es.'
Inf
orm ationsharing isa f
unctionofthe °oor w hic h isd i± c ult to replic ate inelec tronic
trad ing system s. T hese system susually restric t the set ofm essagesthat c anb e sent b y
users(generally trad ersc anonly post pric esand quantities).Furtherm ore trad inginthese
system sisinm ost c asesanonym ous. T hisf
eature preventstrad ersf
rom d eveloping the
reputationofhonestly sharinginf
orm ationthrough enduringrelationships.
Inf
orm ationsharingonthe °oor c antake plac e b etw eentw o typesofpartic ipants.F irst
°oor-b rokersc anexc hange inf
orm ationontheir trad ing motivationsw ith m arket-makers.
B enveniste,M arc usand W hilelm (199 2 ) m od elthistype ofinf
orm ationsharingand show
that it m itigatesad verse selec tion.Sec ond °oor-b rokersc anc ommunic ate w ith other °oor-
b rokers.For instance,So¯anosand W erner (1997),p.
6 notic e that
`Inad d ition, by standinginthe c row d , °oor brokersmay learnabout ad d itional
broker-represented liquid ity that is not re°ec ted inthe spec ialist quotes: °oor
brokers w illof
tenexc hange inf
orm ationontheir intentions and capabilities,
espec ially w ith competitorsw ith w hom they have good w orkingrelationships.'
O ur purpose inthispaper isto analyz e thistype ofinf
orm ationsharing.At ¯rst glance,
inf
orm ationsharing am ong °oor b rokersispuzz ling.Inf
ac t standard m od elsw ith asym -
m etric inf
orm ation(e.
g.K yle (19 85)) show that inf
orm ed trad ersw ant to hid e their inf
or-
m ationrather thand isclose it to potentialc om petitors.Furtherm ore,inf
orm ationsharing
reinf
orc esinf
orm ationalasymetriesb etw eenthose w ho share inf
orm ationand those w ho
d o not.It istheref
ore not ob viousthat it should im prove m arket quality.Hence w e ad -
d resstw o questions.F irst, isit optimalf
or °oor b rokersto share inf
orm ationw ith their
c om petitors? Sec ond, w hat isthe e®ec t ofinf
orm ationsharing am ong °oor b rokerson
the overallperf
orm ance ofthe m arket? Inpartic ular w e stud y the impac t ofinter-°oor
b rokersc om munic ationonstandard m easuresofm arket quality, nam ely pric e volatility,
pric e d iscovery,m arket liquid ity and trad ingc osts.
W e m od el°oor trad ingand inf
orm ationsharingusingK yle (1985)'sm od elasa w orkhorse.
AsinR oÄell(199 0 ),w e assum e that trad ers(°oor b rokers) have ac c essto tw o typesofin-
f
orm ation: (i) f
undamentalinf
orm ationw hic h isinf
orm ationonthe payo® ofthe sec urity
and (ii) non-f
undam entalinf
orm ationw hic h isinf
orm ationonthe volume ofliquid ity(non-
inf
orm ed ) trad ing.W e c onsid er the possib ility f
or tw o °oor b rokersendow ed w ith d i®erent
2
typesofinf
orm ation(one hasf
undam entalinf
orm ationand the other hasnon-f
undamental
inf
orm ation) to share inf
orm ation.M ore spec i¯c ally w e assum e that °oor b rokershave in-
f
orm ationsharingagreem ents(they f
orm a \c lique").Anagreem ent spec i¯esthe prec ision
w ith w hic h eac h b roker reportshisor her inf
orm ationto the other b roker.Af
ter rec eiving
f
undam entalor non-f
undam entalinf
orm ation,the b rokersina c lique pooltheir inf
orm ation
ac c ord ingto the term softheir agreem ent just b ef
ore sub m ittingtheir ord ersf
or exec ution.
W e estab lish the f
ollow ingresults.
²T here isa w id e range ofparam etersfor w hich it isoptim alfor °oor b rokersto share
their inf
orm ation(i.e.their expec ted pro¯tsare larger w ith inf
orm ationsharing).
²Inform ationsharing c anim prove or impair the d epth ofthe market, d epending on
the valuesofthe parameters.
²Inform ationsharingalw aysred uc esthe aggregate trad ingc ostsfor liquid ity trad ers.
How ever w heninf
orm ationsharingim pairsm arket d epth,som e liquid ity trad ersare
hurt.
²Inform ationsharingoc c ursat the expense ofthe °oor b rokersw ho are not part to
the inf
orm ationsharingagreem ent.
²Inform ationsharingimprovespric e d iscovery and red uc esm arket volatility.
Intuitively inf
orm ationsharing intensi¯esc om petitionb etw een°oor b rokersand inthis
w ay it low ersthe totalexpec ted pro¯tsofall°oor b rokers(red uc esthe aggregate trad ing
c osts). Inf
orm ationsharing also c hanges the alloc ationoftrad ing pro¯ts am ong °oor
b rokers.M ore spec i¯c ally the °oor b rokersw ho share inf
orm ationc apture a larger part of
the totalexpec ted pro¯ts, at the expense of°oor b rokersw ho d o not share inf
orm ation.
T hese tw o e®ec ts explainw hy inf
orm ationsharing c ansimultaneously b ene¯t liquid ity
trad ersand the °oor b rokersw ho share their inf
orm ation. O verallinf
ormationsharing
b etw een°oor b rokersisanad vantage f
or °oor-b ased trad ingsystem ssince it resultsin(a)
low er trad ingc osts, (b ) f
aster pric e d iscovery and (c ) low er pric e volatility.Interestingly,
inline w ith our result, Venkataram an(2 0 0 0 ) ¯ndsthat trad ing c ostsonthe NY SE are
low er thanonthe P arisB ourse (anautom ated trad ingsystem ),c ontrollingf
or d i®erences
instocksc harac teristic s.
6
6
T heissen (1 999)compares e®ective bid-askspreads in an automated tradingsystem (X etra)and the
° oorofthe FrankfurtStock Exchange forstocks thattrade in both systems.H e ¯nds thatthe average
3
O ur analysisisrelated to the literature oninf
ormationsales(e.g.Ad m atiand P °eid erer
(19 86), (19 88) and F ishm anand Hagerty (199 5)). Inc ontrast w ith this literature, w e
assum e that the m ed ium f
or inf
orm ationexc hange isinf
orm ation, not m oney. Ac tually
inour m od el, the trad er w ho rec eivesinf
orm ationrew ard sthe inf
orm ationprovid er b y
d isclosinganother type ofinf
orm ation.Hence w e c onsid er °oor-b ased system sasm arkets
f
or trad ingsharesand f
orum to b arter inf
orm ation.Another im portant d i®erence isthat w e
c onsid er c om munic ationofinf
orm ationonthe volum e ofliquid ity trad ing.W e show that
it m ay b e optim alto `
sell'(b arter) suc h aninf
orm ationand that salesofnon-f
undam ental
inf
orm ationhave anim pac t onmarket quality.
T he m od elisd escrib ed inthe next sec tion.Sec tion3 show sthat it c anb e optim alf
or
°oor b rokersto share inf
orm ation.Sec tion4 analyz esthe im pac t ofinf
orm ationsharing
onvariousm easuresofm arket perf
orm ance.Sec tion5 c onclud es.T he proof
sw hic h d o not
appear inthe text are inthe Appendix.
2
T he M od el
2 .
1
Inf
orm ationSharin
gAgreem en
ts
T he T rad ingCrow d .
W e c onsid er a m od eloftrad inginthe market f
or a riskysec urityw hic h isb ased onK yle
(19 85). T he ¯nalvalue ofthe sec urity, w hic h isd enoted ~
v, isnorm ally d istrib uted w ith
m ean¹ and a variance ¾
2
v
that w e norm alize to 1.T his¯nalvalue ispub lic ly revealed at
d ate 2 .T rad inginthissec uritytakesplac e at d ate 1.At thisd ate,investorssub mit m arket
ord ersto b uy or to sellsharesofthe sec urity.T he exc essd em and (supply) isc leared at
the pric e posted b y a c ompetitive and risk-neutralm arket m aker.
T he trad ing \c row d " f
or the sec urity isc om posed ofN + 1 °oor b rokers.
7
At tim e
1, there are tw o typesof°oor b rokers: (i) N f
undam entalspec ulatorsand (ii) one non
f
undam entalspec ulator, B .Fundam entalspec ulatorshave inf
orm ationonthe ¯nalvalue
ofthe sec urity.For simplic ity,asinK yle (19 85),w e assum e that theyperf
ec tlyob serve this
¯nalvalue,just b ef
ore sub m ittingtheir ord ersat d ate 1.B roker B , the non-f
undamental
quoted spreads on the° oorcan belargerorsmallerthan in theautomated tradingsystem,dependingon
thestockcharacteristics.O naveragethequotedspreads areequal.T his is consistentwithourresultthat
theimpactofinformation sharingon marketdepth is ambiguous.
7
T hemarket-makercan alsobeconsidered as beinga° oorbrokerwhohas noinformation.
4
spec ulator, rec eivesord ersf
rom liquid ity trad ers. W e d enote ~
x
B
the totalquantity that
b roker B m ust exec ute onb ehalfofliquid ity trad ers.Asa w hole, liquid ity trad ershave
a net d em and equalto ~
x = ~
x
0
+ ~
x
B
shares. W e assume that ~
x
0
and ~
x
B
are norm ally
and independently d istrib uted w ith m eans0 and variances¾
2
0
and ¾
2
B
respec tively. W e
norm alize the variance ofthe ord er °ow d ue to liquid ity trad ing,¾
2
x
,to 1,i.e.
:
¾
2
x
= ¾
2
B
+ ¾
2
0
= 1:
Inthisw ay,¾
2
B
c anb e interpreted asb roker B 'sm arket share ofthe totalord er °ow f
rom
liquid ity trad ers.T he rem ainingpart ofthe ord er °ow c anb e seenasb einginterm ed iated
b y °oor b rokersw ho d o not trad e f
or their ow nac c ount or asb eing routed elec tronic ally
to the °oor.
8
,
9
B oth typesofspec ulatorsc anengage inproprietary trad ing. Inpartic ular b roker B
c anac t b oth as anagent (she c hannels a f
rac tionofliquid ity trad ers' ord ers) and as
a principal(she sub mitsord ersf
or her ow nac c ount). T hisprac tic e isknow nas`
d ual-
trad ing' and isauthoriz ed insec uritiesm arkets(see Chakravarty and Sarkar (2 0 0 0 ) f
or a
d iscussion).
10
M od elsw ith d ual-trad inginclud e R Äoell(19 90 ),Sarkar (199 5) or F ishm anand
Longsta® (199 2 ).Inthese m od els,asinthe present artic le,b rokersengaged ind ual-trad ing
exploit their ab ility to ob serve ord erssub m itted b y uninf
orm ed (liquid ity) trad ers.
11
None
ofthese m od elshasc onsid ered inf
orm ationsharing off
und am entaland nonf
undam ental
inf
orm ationam ong b rokers, how ever.O ur purpose isto stud y the e®ec tsofthisac tivity.
Asargued inthe introd uc tion,thistype ofinf
orm ationexchange isa d istinctive f
eature of
°oor m arkets.T he spec ulatorsw ith f
undam entalinf
ormationc anb e seenasb rokersw ho
exc lusively trad e f
or their ow nac c ount (like scalpersand loc alsind erivativesm arkets).
T hey c ould also b e seenasb rokersw ho have no c ustom ers' ord ersto exec ute at d ate 1.
It isreasonab le to assume that the ord er °ow f
rom liquid ity trad ersisindependent
ac rossb rokers (f
or instance b rokers have d i®erent c lients). Inc ontrast, signals onthe
f
undam entalvalue ofthe sec urity are c orrelated . For these reasons, w e assum ed that
only one °oor b roker ob servesthe non-f
undam entalinf
ormation, ~
x
B
,w hereasseveral°oor
8
In the U .
S, fullline brokerage houses engage in proprietary trading activities.D iscountbrokers do
not,however.
9
Forinstance, on the N Y SE,orders can reach amarket-makerthrough ° oorbrokers orelectronically
through asystem called SuperD ot.
1 0
Forinstance, Chakravarty and Sarkar(20 0 0 )observe thatin the N Y SE potentialdualtraders are
nationalfulllinebrokeragehouses andtheinvestmentbanks.
1 1
See also M adrigal(1 996). W e borrowthe distinction between `fundamental'vs. `
non-fundamental'
speculators from this author.
5
b rokersob serve the f
undamentalinf
orm ation,~
v.W e have analyz ed the m od elw henthere is
m ore thanone non-f
und am entalb roker (w ith independent ord er °ow ) and b rokersperf
ec tly
share inf
orm ation(inf
orm ationsharingisd escrib ed b elow ).T he presentationofthe m od el
ism ore c om plex b ut the c onclusionsare qualitatively sim ilar to those w e ob taininthe
c ase w ith only one non-f
undamentalb roker. O ne reasonf
or w hic h the m od elis more
c om plexisthat the numb er ofc liques(groupsofpaired b rokersw ith d istinct inf
ormation)
isendogenous. Inequilib rium , thisnum b er c anb e sm aller thanthe m aximum possib le
numb er ofc liques.For instance ifthere isanequalnumb er, N , off
und am entaland non-
f
undam entalb rokers, the numb er ofc liquesc anb e sm aller thanN . Inpartic ular, w ith
perf
ec t inf
ormationsharing, thisisnec essarily the c ase w hen¾
2
0
= 0 . Inthisc ase, the
aggregate ord er °ow c hanneled b y the non-f
undam entalb rokersw ho are not a± liated to
a c lique playsthe role of~
x
0
inthe present artic le.
In
f
orm ationSharin
g.
W e mod elinf
orm ationsharing asf
ollow s.W e assume that the nonf
undam entalspec -
ulator, B , hasanagreem ent to share inf
orm ationw ith one f
und am entalspec ulator, S.
Ac c ord ing to thisagreem ent, b ef
ore trad ing at d ate 1, the non-f
und am entalspec ulator
sendsa signal
^
x = ~
x
B
+ ~
´;
to the f
undam entalspec ulator.Inexc hange,the f
undam entalspec ulator sendsa signal
^
v = ~
v + ~
";
to the nonf
undam entalspec ulator.T he random variab les~
´ and ~
" are independently and
norm allyd istrib uted w ith meanzero and variances¾
2
´
and ¾
2
"
,respec tively.W e ref
er to the
inverse of¾
2
´
(resp.¾
2
"
) asthe prec isionofthe signalsent b y b roker B (S).T he larger is¾
2
´
(¾
2
"
),the lessprec ise isthe signalsent b y spec ulator B (spec ulator S) and hence the low er
isitsinf
orm ative value.T w o polar c asesare ofpartic ular interest.F irst there isperf
ec t
inf
ormationsharingif¾
2
´
= ¾
2
"
= 0 .Sec ond there isno informationsharingif¾
2
´
= ¾
2
"
=
1 .
In-b etw eenthese tw o c ases, there isinf
orm ationsharing b ut it isim perf
ec t (at least one
spec ulator d oesnot perf
ec tly d isclose hisor her inf
orm ation). T he inf
orm ationsetsof
spec ulatorsB and S at d ate 1 are d enoted y
B
= (~
x
B
; ^
x;^
v) and y
S
= (~
v; ^
x; ^
v),respec tively.
Inreality °oor b rokersare likely to exc hange inf
orm ationw ith the b rokersw ith w hom
they have enduring relationships.Inthisc ase their d ec isionto share inf
orm ationw ith a
6
givenb roker must b e b ased onthe long-term (average) b ene¯tsofinf
ormationsharing.For
thisreason,w e assum e that the spec ulatorsd ec id e to share inf
ormationb yc om paringtheir
ex-ante (i.e.prior to rec eivinginf
orm ation) expec ted pro¯tsw ith and w ithout inf
orm ation
sharing.W e say that inf
orm ationsharingispossib le ifthere existsa pair (¾
2
´
,¾
2
"
) suc h that
the expec ted pro¯tsofspec ulator S and B are larger w henthere isinf
orm ationsharing.
Insec tion3,w e id entif
y param eters' valuesf
or w hic h inf
orm ationsharingispossib le.
R em arks.
It isw orth stressingthat w e f
oc usonthe possib ilityofaninf
orm ationsharingagreem ent
b ut not onitsimplementation. Inpartic ular, w e d o not ad d ressenf
orc em ent issues. In
that, w e f
ollow the literature oninf
orm ationsalesw here the quality ofthe inf
orm ation
w hich issold isassum ed to b e c ontrac tib le.
12
W e also assum e that the inf
orm ationsharing
agreem ent and its c harac teristic s (¾
2
´
;¾
2
"
) are know nb y allpartic ipants (includ ing the
m arket-m aker).T hisc om monknow led ge assum ptionisalso standard inthe literature on
inf
orm ationsales.
2 .
2
T he equil
ib rium ofthe F l
oor M arket
Inthissec tion,w e d erive the equilib rium ofthe trad ingstage at d ate 1,giventhe c harac -
teristic softhe inf
ormationsharingagreement b etw eenspec ulatorsB and S.T hen,inthe
next sec tion,w e analyze w hether or not it isoptim alf
or B and Sto exc hange inf
orm ation.
W e d enote b y Q
S
(y
S
) and Q
B
(y
B
), the ord erssub m itted b y spec ulatorsS and B , re-
spec tively.Inthe set off
undamentalspec ulators, w e assignindex1 to spec ulator S.An
ord er sub m itted b y the other f
undamentalspec ulatorsi= 2 ;:::;N isd enoted Q
i
(~
v).T he
totalexc essd emand that must b e c leared b y the c om petitive m arket m aker istheref
ore
O =
i= N
X
i= 2
Q
i
(~
v) + Q
S
(y
S
) + Q
B
(y
B
) + ~
x:
Asthe market maker isassum ed to b e c om petitive,he setsa pric e p(O ) equalto the asset
1 2
See A dmati and P ° eiderer(1 986),(1 988).Some papers have shown howincentives contracts can be
used toinduce an information providertotruthfully revealthe quality ofhis signal(see A llen (1 990 )or
B hattacharya and P ° eiderer(1 985)). R eputation e®ects may also help to sustain information sharing
agreements (seeB enabou andL aroque (1 992)).
7
expec ted value c onditionalonthe net ord er °ow ,i.e.
p(O ) = E(~
v
jO ):
(1)
Anequilib rium c onsistsoftrad ing strategiesQ
S
(:), Q
B
(:), Q
i
(:);i= 2 ;:::;N and a c om -
petitive pric e f
unctionp(:) suc h that (i) eac h trad er'strad ingstrategy isa b est response to
other trad ers' strategiesand (ii) the d ealer'sb id d ing strategy isgivenb y E quation(1).
13
For givenc harac teristic s, (¾
2
´
;¾
2
"
), ofaninf
ormationsharing agreement, the next lemm a
d escrib esthe unique linear equilib rium ofthe trad inggam e.
Lem m a 1 : T he trad ingstage hasa unique linear equilibrium w hic h isgivenby
p(O ) =
¹ + ¸O ;
(2 )
Q
S
(y
S
) =
a
1
(~
v
¡¹)+ a
2
(^
v
¡¹)+ a
3
^
x;
(3)
Q
i
(~
v) =
a
0
(~
v
¡¹);i= 2 ;:::;N
(4 )
Q
B
(y
B
) =
b
1
~
x
B
+ b
2
^
x + b
3
(^
v
¡¹),
(5)
w here coe± c ientsa
1
;a
2
;a
3
;a
0
;b
1
;b
2
;b
3
and ¸ are
a
1
=
3(¾
2
v
+ ¾
2
"
)
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
;
a
2
=
¡
¾
2
v
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
;
a
3
=
¡
¾
2
B
3
¡
¾
2
B
+ ¾
2
´
¢;
a
0
=
2 ¾
2
v
+ 3¾
2
"
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
;
b
1
=
¡
1
2
;
b
2
=
¾
2
B
6
¡
¾
2
B
+ ¾
2
´
¢;
b
3
=
2 ¾
2
v
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
;
1 3
M oreprecisely,weconsidertheP erfectB ayesian Equilibriaofthe tradinggame.
8
and
¸ (¾
2
"
;¾
2
´
) =
6
q
¾
2
v
¡
¾
2
B
+ ¾
2
´
¢
(4 (N + 1)¾
4
v
+ (12 N + 5)¾
2
v
¾
2
"
+ 9 N ¾
4
"
)
(2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
q
¾
2
B
¡
4 ¾
2
B
+ 9¾
2
´
¢
+ 36¾
2
0
¡
¾
2
B
+ ¾
2
´
¢:
T rad erspurc hase (sell) the sec urity w hentheir estimationofthe asset value isab ove
(b elow ) the unconditionalexpec ted value.Hence,the c oe± c ientsa
1
,a
0
and b
3
are positive.
Nonf
undam entalinf
ormationisalso a sourc e ofpro¯t.Intuitively liquid itytrad ers'ord ers
c reate tem porary pric e pressures. B rokersw ith non-f
undam entalinf
orm ationare aw are
ofthese pric e pressures. T hey c anpro¯t f
rom thisknow led ge b y selling (b uying) high
(low ) w henliquid ity trad ers b uy (sell). M ore f
orm ally suppose that the f
undamental
spec ulators(b ut not the market m aker) d o not expec t c hangesinthe sec urity value (i.
e.
~
v = ¹).Suppose also that B and S perf
ec tly share inf
orm ationand that liquid ity trad ers
sub m it b uyord ers.T hese ord erspush the pric e upw ard b ec ause the m arket m aker c annot
d istinguish liquid ity ord ersf
rom inf
orm ed ord ers.Spec ulatorsB and Show ever know that
the c orrec t value ofthe sec urityis¹ .Inantic ipationofthe upw ard pressure onthe c learing
pric e,theysub m it sellord ers.B ysym metry,theysub m it b uyord ersw henliquid itytrad ers
sub m it sellord ers.T hisexplainsw hy c oe± c ientsb
1
and a
3
are negative.T hism eansthat
°oor b rokersB and S partly ac c om m od ate liquid ity trad ers' ord ersand red uc e the ord er
°ow imb alance that must b e exec uted b y the m arket-maker.A similar e®ec t isob tained
inR Äoell(1990 ) and Sarkar (19 95).
T he previousd iscussionshow show spec ulatorsc anpro¯t b oth f
rom f
und am entaland
nonf
undam entalinf
ormation. Hence there isa b ene¯t to exc hange f
undam ental(non-
f
undam ental) inf
orm ationf
or non-f
undam ental(f
und am ental) inf
ormation. Inf
orm ation
sharing isc ostly, how ever. Ac tually spec ulatorsS and B d eprec iate the value oftheir
private inf
orm ationw henthey share it.Consid er spec ulator B f
or instance.Ifshe d oes
not share inf
orm ation(¾
2
´
= +
1 ), she ac c om mod ateshalfofthe ord er °ow she rec eives
(since b
1
=
¡1=2 ).Ifshe sharesinformationthenb rokersB and S (instead ofb roker B
alone) provid e liquid ityto the ord ersc hanneled b yb roker B .For instance ifthere isperf
ec t
inf
orm ationsharing theneac h b roker ac c om mod atesone third ofthe ord ersrec eived b y
b roker B (since b
1
+ b
2
=
¡1=3 and a
3
=
¡1=3 w hen¾
2
´
= 0 ).T hisc ompetitionf
or the
provisionofliquid ity hastw o e®ec ts. F irst, b roker B trad essm aller quantities.Sec ond,
the ord er imb alance that must b e exec uted b y the m arket-m aker issm aller.Hence, f
or a
9
givenpric e sched ule (a ¯xed ¸ ), pric esreac t lessto the ord er °ow .
14
Inf
ac t spec ulator
B red uc esher trad e size w henshe sharesinf
orm ation(b
2
hasa signopposite the signof
b
1
) prec isely to m itigate thise®ec t.T hese tw o e®ec ts(sm aller trad e siz e/sm aller ab solute
pric e m ovem ents) red uc e spec ulator'sB pro¯tsonnon-f
undamentalinf
orm ation.T hisis
the c ost ofsharingnon-f
undam entalinf
orm ation.
A sim ilar argum ent holdsf
or spec ulator S. He d eprec iatesthe value off
undam ental
inf
orm ationw henhe sharesit w ith spec ulator B .Inord er to m itigate thise®ec t,he ad justs
histrad ingstrategy to the message he send sto spec ulator B .T hisexplainsw hy a
2
hasa
signopposite a
1
.
T o sum up,inf
orm ationsharinghasb ene¯tsand c osts.Inf
ormationsharingisa sourc e
ofpro¯tssince it allow seac h b roker to trad e ona new type ofprivate inf
orm ation.B ut the
b rokersob tainnew inf
orm ationonly ifthey d isclose allor part oftheir inf
orm ation.T his
isc ostlysince it red uc esthe trad ingpro¯tsthat c anb e mad e onthe inf
orm ationoriginally
possessed b y a b roker.Inthe next sec tionw e show that the b ene¯t ofinf
orm ationsharing
c anoutw eight itsc ost.
3 IsInf
orm ationSharingP ossib l
e?
Inthissec tion, w e id entif
y c asesinw hic h spec ulatorsB and S are b etter o® w henthey
share inf
orm ation. W e start b y c onsid ering the e®ec t ofthe prec isionsw ith w hic h the
spec ulatorsB and S share their inf
orm ationonthe m arket d epth (m easured b y ¸
¡1
).
15
It
turnsout that thise®ec t isim portant to interpret the results.
Lem m a 2 : T he d epth ofthe m arket (i.e. ¸
¡1
) isa® ec ted by the prec isionsw ith w hic h
the f
undamentaland the nonf
undam entalspec ulatorsshare their inf
ormation.
1.T he m arket d epth increasesw ith the prec isionofthe signalsent bybroker S(
@¸
@¾
2
"
> 0 ),
2 .T he market d epth d ec reasesw ith the prec isionofthe signalsent by broker B (
@¸
@¾
2
´
<
0 ).
1 4
Inordertoconveytheintuitionwetake¸ as given.H owevertheslopeofthepricescheduleis a®ected
by information sharing. A s shown below (L emma 2)sharing non-fundamentalinformation enlarges ¸.
T his mitigates theloss in pro¯tduetotheseconde®ect(smallerpricechanges).
1 5
T hemarketdepth is theorder° ownecessarytochangetheprice by1 unit.T helargeris the market
depth,the greateris the liquidityofthe market.A ctually,when ¸ is small,the market-makeraccommo-
dates largeorderimbalances withoutsubstantialchanges in prices.
10
Notic e that anincrease inthe quality ofthe inf
orm ationprovid ed b y B to S enlarges¸,
that isit d ec reasesthe d epth ofthe m arket. T he intuitionf
or thisresult isasf
ollow s.
E xc hange ofnon-f
und am entalinf
orm ationincreasesthe role of°oor b rokers(B and S) in
the provisionofliquid ity.T o see thispoint, let Q
T
= Q
B
+ Q
S
b e the totaltrad e siz e of
spec ulatorsB and S and c onsid er their expec ted totaltrad e siz e c ontingent on~
x
B
= x
B
.
W e ob tain
E(Q
T
j~x
B
= x
B
) = (b
1
+ b
2
+ a
3
)(x
B
) =
¡(
1
2
+
¾
2
B
6(¾
2
B
+ ¾
2
´
)
)(x
B
):
(6)
T he sm aller is¾
2
´
,the larger isthe f
rac tion(
jb
1
+ b
2
+ a
3
j) ofthe ord ersrec eived byb roker B
w hich isac c omm od ated b y spec ulatorsSand B .Asa c onsequence the d ealer partic ipates
lessto liquid itytrad es.Inthissense the exc hange ofnon-f
und am entalinf
orm ation`
siphons'
uninf
orm ed ord er °ow aw ay f
rom the m arket-m aker.T husthissiphone® ec t increaseshis
exposure to inf
orm ed trad ingand the pric e sched ule b ec om essteeper.
16
Interestingly anincrease inthe quality ofthe inf
orm ationprovid ed b y S to B has
exac tly the opposite e®ec t: it im provesthe d epth ofthe m arket.Inthisc ase, the e®ec t
ofinf
orm ationsharingisto increase c ompetitionam ongf
undam entaltrad ers.Hence they
scale b ack their ord er siz e (a
1
and a
0
d ec rease w hen¾
2
"
d ec reases).T hise®ec t red uc esthe
m arket-m aker'sexposure to inf
orm ed trad ing and thereb y m akesthe pric e sched ule less
steep.
W e d enote spec ulator j'sex-ante expec ted pro¯t (i.
e.b ef
ore ob servinginf
orm ation) b y
¦
j
(¾
2
´
;¾
2
"
;N ) .U singLem m a 1,w e ob tainthe f
ollow ingresult.
Lem m a 3 : F or givenvaluesof¾
2
"
and ¾
2
´
, the expec ted trad ingpro¯ tsfor spec ulatorsB
1 6
In equilibrium informed traders scale backtheirordersize when ¸ increases.B utthis is insu±cient
tocompensatethereduction in uninformed tradingdue tothe siphone®ect.
11
and S are
¦
S
(¾
2
´
;¾
2
²
;N ) =
Ã
¾
2
v
(¾
2
v
+ ¾
2
"
)(4 ¾
2
v
+ 9 ¾
2
"
)
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
2
+
¸¾
4
B
9
¡
¾
2
B
+ ¾
2
´
¢
!
d ef
=
¦
S
f
(¾
2
´
;¾
2
"
;N ) + ¦
S
n f
(¾
2
´
;¾
2
"
;N );
an d ;
¦
B
(¾
2
´
;¾
2
"
;N ) =
Ã
4 ¾
4
v
(¾
2
v
+ ¾
2
"
)
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
2
+
¸¾
2
B
¡
4 ¾
2
B
+ 9 ¾
2
´
¢
36
¡
¾
2
B
+ ¾
2
´
¢
!
d ef
=
¦
B
f
(¾
2
´
;¾
2
"
;N ) + ¦
B
n f
(¾
2
´
;¾
2
"
;N ):
E ach spec ulator'sexpec ted pro¯tshastw o c om ponents: (i) the expec ted pro¯t she or he
ob tainsb y trad ing onf
undam entalinf
orm ation(¦
j
f
) and (ii) the expec ted pro¯t she or
he ob tainsb y trad ing onnon-f
undam entalinf
orm ation(¦
j
nf
). Aninf
orm ationsharing
agreem ent isviab le ifand only ifb oth spec ulatorsB and Sare b etter o® w henthey share
inf
orm ation.Hence aninf
orm ationsharingagreem ent ispossib le ifand only ifthere exists
a pair (¾
2
´
;¾
2
"
) such that
¡
B
¡
¾
2
´
;¾
2
"
;N
¢
d ef
= ¦
B
(¾
2
´
;¾
2
"
;N )
¡¦
B
(
1 ;1 ;N ) > 0 ;
(7)
and
¡
S
¡
¾
2
´
;¾
2
"
;N
¢
d e f
= ¦
S
(¾
2
´
;¾
2
"
;N )
¡¦
S
(
1 ;1 ;N ) > 0 :
(8)
T he ¡s' m easure the expec ted surplusassoc iated w ith the inf
orm ationsharingagreem ent
f
or spec ulatorsB and S.
P roposition1 : T he set ofparametersf
or w hic h spec ulatorsB and S share information
isnon-empty.
W e estab lish the result b y provid ing 3 num eric alexam ples. For eac h exam ple, w e
report inT ab les1, 2 and 3 b elow the b reak-d ow nofthe trad ing pro¯tsf
or the d i®erent
partic ipantsw ith and w ithout inf
orm ationsharing. W e also c ompare the m arket d epth
w ith and w ithout inf
orm ationsharing. T he exam ples have b eenc hosenb ec ause they
illustrate d i®erent phenom ena that w e w illd iscussinthe rest ofthe paper.T he trad ing
pro¯tsare scaled b y ¾
2
v
and ¾
2
x
that w e norm aliz e to 1 throughout the paper.
12
P roof
:
E xam pl
e 1: ¾
2
0
= 0 ,¾
2
"
= 0 ,¾
2
´
= 2 =3,N = 2 .
P ro¯tsand d epth
Inf
orm ationSharing No In
f
orm ationSharin
g
(N
¡1)£¦
i
f
i
6
= S;B
0 :0 589
0 :1178
¦
S
f
0 :0 589
0 :1178
¦
S
nf
0 :0 70 7
0
¦
B
f
0 .0589
0
¦
B
nf
0 :1767
0 :2 357
T otalE xpec ted P ro¯ts 0 :4 2 4 2
0 :4 714
M arket Depth (¸ )
1:0 60 7
0 :94 2 8
T ab l
e 1
Inthisc ase w e ob tainthat
¡
S
= ¦
S
f
+ ¦
S
nf
¡¦
S
(
1 ;1 ) = 0 :0 589 + 0 :0 70 7¡0 :1178 = 0 :0 118;
and
¡
B
= ¦
B
f
+ ¦
B
nf
¡¦
B
(
1 ;1 ) = 0 :0 589 + 0 :1767¡0 :2 357= 0 :
O b serve that the totalsurplusf
or spec ulatorsB and S ispositive and equalto
¡
S
+ ¡
B
= 0 :0 118;
b ut that the totalsurplusf
or allspec ulatorsisnegative and equalto
(N
¡1)¡
i
+ ¡
S
+ ¡
B
= (0 :0 589
¡0 :1178)+ 0 :0 118 = ¡0 :0 4 71:
(¡
i
d enotesthe d i®erence inthe expec ted pro¯t w ith and w ithout inf
orm ationf
or a spec -
ulator d i®erent f
rom S or B .
)
E xam pl
e 2 : ¾
2
0
= 0 :6,¾
2
"
= 0 ,¾
2
´
= 0 ,N = 10 .
13
P ro¯tsand Depth
Inf
orm ationSharing No In
f
orm ationSharin
g
(N
¡1)£¦
i
f
i
6
= S;B
0 :1815
0 :2 165
¦
S
f
0 :0 2 0 2
0 :0 2 4 1
¦
S
nf
0 :0 153
0
¦
B
f
0 .02 0 2
0
¦
B
nf
0 :0 153
0 :0 34 4
T otalE xpec ted P ro¯ts 0 :2 52 5
0 .274 9
M arket Depth (¸)
0 .34 4 3
0 .34 36
T ab l
e 2
Inthisc ase w e ob tainthat
¡
S
= ¦
S
f
+ ¦
S
n f
¡¦
S
(
1 ;1 ) = 0 :0 114 ;
and
¡
B
= ¦
B
f
+ ¦
B
nf
¡¦
B
(
1 ;1 ) = 0 :0 0 11
O b serve that the totalsurplusf
or spec ulatorsB and S ispositive (0 :0 12 5) b ut that the
totalsurplusf
or allspec ulatorsisnegative (
¡0 :0 2 2 4 :)
E xam pl
e 3: ¾
2
0
= 0 :6,¾
2
"
= 0 ,¾
2
´
= 1:3,N = 10 .
P ro¯tsand Depth
Inf
orm ationSharing No In
f
orm ationSharin
g
(N
¡1)£¦
i
f
i
6
= s;B
0 :1874
0 :2 165
¦
S
f
0 :0 2 0 8
0 :0 2 4 1
¦
S
nf
0 :0 0 35
0
¦
B
f
0 .02 9 8
0
¦
B
nf
0 :0 2 9 0
0 :0 34 4
T otalE xpec ted P ro¯ts 0 :2 615
0 :2 74 9
M arket Depth (¸)
0 .033
0 .034
T ab l
e 3
Inthisc ase w e ob tainthat
¡
S
= ¦
S
f
+ ¦
S
n f
¡¦
S
(
1 ;1 ) = 0 :0 0 0 3;
14
and
¡
B
= ¦
B
f
+ ¦
B
nf
¡¦
B
(
1 ;1 ) = 0 :0 155
O b serve that the totalsurplusf
or spec ulatorsB and Sispositive and equalto ¡
S
+ ¡
B
=
0 :0 158.T he totalsurplusf
or allspec ulatorsisnegative and equalto
¡0 :0 134 :
Inallthe exam ples, the joint expec ted pro¯tsofspec ulatorsB and S increase w hen
they share inf
orm ation.Notic e that thisisa nec essary c onditionf
or inf
orm ationsharing.
Ac tually E quations(7) and (8) im ply that
¦
B
(¾
2
´
;¾
2
"
;N ) + ¦
S
(¾
2
´
;¾
2
"
;N ) > ¦
S
(
1 ;1 ;N )+ ¦
B
(
1 ;1 ;N ):
At the sam e tim e, there isa d ec line inthe joint expec ted pro¯tsofthe spec ulatorsw ho
d o not share inf
ormation.E ventually the totalexpec ted pro¯tsf
or allthe spec ulatorsare
low er inallthe exam ples(thisisalw aysthe c ase; see P roposition5 inSec tion4 ).Insum
inf
orm ationsharingisa w ay f
or spec ulatorsB and S to sec ure a larger part ofa sm aller
`cake'.T he f
allintotalpro¯tsisnot surprising: inf
orm ationsharingincreasesc om petition
b etw een°oor b rokers.T he surprisingpart isthat the joint expec ted pro¯tsofspec ulators
B and S c anincrease d espite the d ec line inthe totaltrad ing pro¯tsf
or the spec ulators.
T hisiskey since thisisa nec essary c onditionf
or inf
ormationsharing.W e now provid e an
explanationf
or thisob servation.T he explanationisquite c om plexb ec ause severale®ec ts
interplay.
Consid er the f
ollow ingratio
r
1
(¾
2
"
;¾
2
´
)
d ef
=
E(Q
T
j~v = v)
E(Q
T
j~v = v;¾
2
"
=
1 ;¾
2
´
=
1 )
:
T hisratio c om paresthe expec ted totaltrad e size (Q
T
) ofthe c lique f
orm ed b y spec ulators
B and Sc ond itionalonf
undamentalinf
orm ationw ith and w ithout aninf
orm ationsharing
agreem ent.U singLem m a 1,w e c anw rite thisratio as
r
1
(¾
2
"
;¾
2
´
) =
a
1
(¾
2
"
;¾
2
´
) + a
2
(¾
2
"
;¾
2
´
) + b
3
(¾
2
"
;¾
2
´
)
a
1
(
1 ;1 )
:
Hence r
1
> 1 m eans that the c lique f
orm ed b y B and S trad es m ore aggressively on
f
undam entalinf
orm ationw henthere isinf
orm ationsharingthanw henthere isnot.U sing
15
the expressionsf
or a
1
,a
2
and b
3
giveninLem m a 1,w e eventually ob tain
r
1
(¾
2
"
;¾
2
´
) = (
¸(
1 ;1 )
¸ (¾
2
²
;¾
2
´
)
)(
(4 ¾
2
v
+ 3¾
2
²
)(N + 1)
2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
²
):
As¸(
1 ;1 ) > ¸(0 ;1 ) (Lemm a 2 ),it isim m ed iate that r
1
(0 ;
1 ) > 1.B y c ontinuity,this
inequality also holdstrue f
or other valuesof¾
2
²
and ¾
2
´
. Hence there exist inf
orm ation
sharingagreementsw hic h ind uc e the c lique f
orm ed b y B and Sto trad e m ore aggressively.
Inturnthisf
orc esspec ulatorsw ho are not part ofthe c lique to shad e their totaltrad e
size.T o see thispoint c onsid er the f
ollow ingratio
r
2
(¾
2
²
;¾
2
´
)
d ef
=
E((N
¡1)Q
i
j~v = v)
E((N
¡1)Q
i
j~v = v;¾
2
"
=
1 ;¾
2
´
=
1 )
= (
¸ (
1 ;1 )
¸(¾
2
²
;¾
2
´
)
)(
(2 ¾
2
v
+ 3¾
2
²
)(N + 1)
2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
²
);
w here (N
¡1)Q
i
isthe totaltrad e siz e ofspec ulatorsd i®erent f
rom B and S.U singLem m a
2 ,w e d ed uc e that r
2
increasesw ith ¾
2
´
.T hisim pliesthat
r
2
(¾
2
²
;¾
2
´
)
·r
2
(¾
2
²
;
1 ):
U singthe expressionsf
or ¸(
1 ;1 )and ¸(¾
2
²
;
1 ) giveninthe proofofLem m a 2 ,w e ob tain
17
r
2
(¾
2
²
;
1 ) < 1 8¾
2
²
<
1 :
W e c onclud e that r
2
(¾
2
²
;¾
2
´
) < 1.T hism eansthat inf
orm ationsharingagreem entsf
orc e the
spec ulatorsw ho are not part ofthe c lique to trad e lessaggressively ontheir inf
orm ation.
Hence the spec ulatorsw ho share inf
orm ationappropriate a larger share ofthe totalpro¯ts
w hich d erive f
rom trad ing onf
undam entalinf
orm ation.
18
For thisreason, inf
orm ation
sharing enlargestheir joint expec ted pro¯t onf
undam entalinf
orm ation.T hisisthe c ase
f
or instance inE xamples2 and 3.
Now c onsid er the e®ec t ofinf
orm ationsharing onthe pro¯tsw hich d erive f
rom non-
f
undam entalinf
ormation.O nthe one hand,there are m ore spec ulatorsw ho ac c om m od ate
the ord er °ow b rokered b y B . T hise®ec t d ec reasesthe levelofexpec ted pro¯t onnon-
f
undam entalinf
ormation.O nthe other hand the exc hange ofnonf
undam entalinf
orm ation
1 7
T heproofrequires straightforward manipulations and is availableupon request.
1 8
N oticethatspeculators inourmodelarelikeCournotcompetitors.InCournotcompetition,each¯rm
would like to committo trade a largersize than itdoes in equilibrium. T his commitmentwould force
other¯rms totradeinsmallersizes.Inthis waythecommitted¯rm cancapturealargershareofthetotal
pro¯ts. Intuitively sharing fundamentalinformation is a way to make this commitmentcredible. T his
e®ecthas been pointedoutbyFishman and H agerty(1 995)in amodelofinformation sale.
16
d ec reasesthe market d epth and thise®ec t increasespro¯tsf
rom non-f
undam entalspec -
ulationasc anb e seenf
rom Lem m a 3. It turnsout that there are c ases(f
or instance
E xam ple 1) inw hic h the sec ond e®ec t d ominatesand the joint expec ted trad ingpro¯tsof
spec ulatorsS and B onnon-f
und am entalinf
orm ationare larger w henthere isinf
orm ation
sharingor
¦
B
n f
(¾
2
´
;¾
2
"
;N ) + ¦
S
n f
(¾
2
´
;¾
2
"
;N )
¡¦
B
nf
(
1 ;1 ;N ) ¸0 ; for ¾
2
´
<
1
and
¾
2
"
<
1
O b serve that thisc anoc c ur onlyw heninf
orm ationsharingim pairsm arket d epth (increases
¸).InE xam ple 3,inf
orm ationsharingim provesm arket d epth and the joint expec ted pro¯t
onnon-f
undam entalinf
orm ationd ec reases.
T o sum up, there are tw o reasonsw hy inf
orm ationsharing c anincrease the joint ex-
pec ted pro¯tsofspec ulatorsB and S:
²Sharingfundamentalinformationallow sthe c oalitionform ed b y b rokersSand B to
trad e m ore aggressively onf
undam entalinf
ormationand to c apture thereb y a larger
share ofthe totalpro¯tsf
rom spec ulationonf
undam entalinf
ormation.
²Sharingnon-fundam entalinform ationc anred uc e the m arket d epth.T hisim pliesthat
pric esreac t m ore to ord er imb alances.Larger totalexpec ted pro¯tsf
rom spec ulation
onnon-f
undam entalinf
orm ationf
ollow s.
T he prec isionsw ith w hic h the spec ulatorsshare their inf
orm ationd etermine how the
surplus (¡
S
+ ¡
B
) c reated b y inf
orm ationsharing is split b etw eenb rokers B and S.
For instance, c onsid er E xam ples2 and 3. T he value of¾
2
´
islarger inE xam ple 3, b ut
otherw ise the valuesofthe param etersare id entic alinthe tw o exam ples.T he surplusf
or
spec ulator B (S) islarger (low er) inE xam ple 3 thaninE xam ple 2 .Inline w ith intuition,
f
or a ¯xed value of¾
2
"
,spec ulator B (S) pref
ersto provid e (rec eive) aninf
orm ationoflow
(high) quality. Hence spec ulatorsB and S have c on°ic ting view sover the inf
orm ation
sharingagreem entsw hic h should b e c hosen.It isalso w orth stressingthat the siz e ofthe
surplusc reated b y inf
orm ationsharingd epend sonthe prec isionsw ith w hic h trad ersshare
inf
orm ation. For instance the joint surplusissm aller inE xam ple 2 thaninE xam ple 3.
Inthispaper, w e d o not stud y how trad ersselec t the c harac teristic softheir inf
orm ation
sharing agreem ent (¾
2
²
and ¾
2
´
). T hisisnot nec essary b ec ause our statem entsregard ing
m arket perf
orm ance (next sec tion) only d epend sonthe existence ofinf
orm ationsharing
agreem ents,not onthe spec i¯c valuesc hosenf
or ¾
2
"
and ¾
2
´
.
17
W e now c onsid er inm ore d etailsinf
orm ationsharingagreementsinw hich spec ulatorsB
and Sperf
ec tly share inf
ormation(¾
2
"
= ¾
2
´
= 0 ).P erf
ec t inf
orm ationsharingisofinterest
b ec ause it isrelatively easy to im plement.Ac tually,ifthere isperf
ec t inf
orm ationsharing,
B know s w hich quantity S should trad e and vic e versa (inour m od elthey optimally
trad e the sam e quantity).Consequently, one spec ulator c and etec t cheating b y the other
spec ulator b y ob servinghisor her trad e size.
P roposition2 : For N
¸ 2 , there exist tw o c ut-o® values (i) ¾
2
0
(N ) and (ii) ¾
¤2
0
(N )
suc h that perf
ec t inf
ormationsharingispossible ifand only if¾
2
0
2 [¾
2
0
(N );¾
¤2
0
(N )].Fur-
therm ore the c uto® valuesincrease w ith N and are suc h that 0 < ¾
2
0
(N ) < ¾
¤2
0
(N ) < 1.
T he propositionshow s that perf
ec t inf
orm ationsharing ispossib le ifb roker B d oes
not c hannela too large or a too sm allf
rac tionofthe ord er °ow f
rom liquid ity trad ers.
O b serve that pro¯tsm ad e onnon-f
und am entalinf
orm ation(¦
j
n f
) are proportionalto the
am ount ofliquid itytrad ingb rokered b yB (¾
2
B
= 1
¡¾
2
0
).Hence ¾
2
0
d eterm inesthe value of
non-f
undam entalinf
orm ation.P erf
ec t inf
orm ationsharingc antake plac e w henthisvalue
isneither too large, nor too sm all. Ifthe value ofnon-f
undamentalinf
orm ationislarge
(¾
2
0
< ¾
2
0
(N )),the c ost ofd isclosingher inf
orm ationperf
ec tlyf
or B (sm aller pro¯tsonnon-
f
undam entalinf
orm ation) islarge c om pared to the b ene¯t (the possib ility to pro¯t f
rom
f
undam entalinf
orm ation).Inord er to attenuate thisc ost,B must theref
ore send a noisy
signalto S.W henthe value ofnon-f
und am entalinf
orm ationissm all(¾
2
0
> ¾
¤2
0
(N )), the
b ene¯t ofperf
ec t inf
ormationsharing issm allf
or the f
und am entalspec ulator.T heref
ore
he ref
usesto perf
ec tly d isclose hisinf
orm ation.
T he larger isthe numb er off
undam entalspec ulators, the sm aller must b e the f
rac tion
ofliquid ity trad ers' ord er °ow b rokered b y B to sustaina perf
ec t inf
orm ationsharing
agreem ent (¾
2
0
(N ) increasesw ith N ).Ac tually the pro¯tsf
rom f
und am entalinf
orm ation
d ec rease w ith the numb er off
undamentalspec ulators.T he value off
und am entalinf
orm a-
tionistheref
ore sm allw henN islarge.Hence b roker B ac c eptsto perf
ec tly d isclose her
inf
orm ationonly ifthe value ofnon-f
undam entalinf
orm ationisitselfsm all.T he last part
ofthe propositionim pliesthat f
or allvaluesofN ,there exist valuesof¾
2
0
< 1 such that a
perf
ec t inf
orm ationsharingagreem ent c anb e sustained .F igure 1 plots¾
2
0
(N ) and ¾
¤2
0
(N )
f
or d i®erent valuesofN
¸2 and show sw henperfec t informationsharingispossib le.
19
1 9
T hecuto®values ¾
2
0
(N )and ¾
¤2
0
(N )areimplicitlyde¯nedin theproofofP roposition 2.
18
R em ark.Inthe mod elw e assum e that b rokers' rolesare ¯xed : one hasf
undamental
inf
orm ationand the other hasnon-f
undam entalinf
orm ation.Another possib ility isthat
the rolesare random ly alloc ated b ef
ore trad ingand unkw now nat the tim e b rokersd ec id e
to share inf
orm ation.For sim plic ity, assum e that eac h b roker inthe c lique hasanequal
prob ab ility to b e the b roker endow ed w ith non-f
undamentalinf
orm ation. Inthisc ase,
b rokersagree to share inf
orm ationi®
¦
B
(¾
2
´
;¾
2
"
;N ) + ¦
S
(¾
2
´
;¾
2
"
;N ) > ¦
S
(
1 ;1 ;N )+ ¦
B
(
1 ;1 ;N ):
T hisc ond itionisalw ayssatis¯ed w hen(¾
2
"
;¾
2
´
) are suc h that Conditions(7) and (8) are
satis¯ed . Hence ifaninf
orm ationsharing agreem ent ispossib le w henb rokers' rolesare
¯xed ,it isstillpossib le w henb rokers' role are randomly c hosen.
4
Inf
orm ationSharin
g and M arket P erf
orm ance
Inthissec tion, w e analyze the e®ec tsofinf
orm ationsharing ontrad itionalm easuresof
m arket quality: (1) the inf
orm ationale± c iency ofpric es(m easured b y V ar(~
v
jp)), (2 )
pric e volatility (measured b y V ar(~
v
¡p)),(3) m arket d epth (m easured by ¸) and (4 ) the
expec ted trad ingc ostsb orne b y liquid ity trad ers(i.e.their expec ted losses,E(~
x(p
¡~v))).
T hese aspec tsofm arket perf
ormance play a prom inent role inthe d eb atesregard ing the
d esignoftrad ingsystem sand have attrac ted c onsid erab le attentioninthe literature (see
M ad havan(19 96) or Vives(19 95) f
or instance).
P rop osition3 : P rices are more inf
orm ative (V ar(~
v
j p) smaller) and less volatile
(V ar(~
v
¡p) smaller) w henthere isinformationsharing.
T he intuitionb ehind thisresult issim ple.W henspec ulatorsSand B share inf
orm ation,
the numb er ofspec ulatorstrad ing onf
undam entalinf
orm ationincreases.It f
ollow sthat
the aggregate ord er °ow ism ore inf
ormative. For thisreason, pric esare m ore ac c urate
pred ic torsofthe ¯nalvalue ofthe sec urity and pric e d iscovery isim proved .
W e now examine the im pac t ofinf
orm ationsharing onthe d epth ofthe m arket. As
show nb y Lem m a 2 , anincrease inthe prec isionw ith w hic h spec ulator S transm itshis
inf
orm ationim proves market d epth. How ever, anincrease inthe prec isionw ith w hich
spec ulator B transm itsher inf
orm ationim pairsm arket d epth (b ec ause ofthe siphone®ec t).
19
Hence the im pac t ofinf
ormationsharing onm arket d epth c anb e positive or negative.
O fc ourse, f
or the param eterssuc h that inf
orm ationsharing oc c urs, one e®ec t c ould b e
d om inant. How ever E xam ples2 and 3 inthe previoussec tionshow that thisisnot the
c ase.Inthese exam ples, ¾
2
²
and ¾
2
´
are suc h that (i) inf
orm ationsharing isoptim aland
(b ) inf
ormationsharing im pairs m arket d epth (E xam ple 2 ) or im proves market d epth
(E xam ple 3).T he next propositionc onsid ersthe e®ec t ofperf
ec t inf
orm ationsharing on
m arket d epth.T o thisend,w e d e¯ne
¹
¾
2
0
(N ) =
1
¡h
2
(N )
8h
2
(N )
¡3
< 1;
w here h (N ) =
2 (N + 2 )
p
N
3(N + 1)
p
N + 1)
< 1:
P roposition4 : P erf
ec t informationsharingim provesm arket d epth ifand only if¾
2
0
¸
¹
¾
2
0
(N ).
Hence perf
ec t inf
ormationsharing im provesm arket d epth w henb roker B rec eivesa suf
-
¯c iently sm allf
rac tionofthe totalord er °ow (¾
0
¸ ¹¾
2
(N )). R ec allthat w henthere is
perf
ec t inf
ormationsharing,¾
2
0
must b e larger thana threshold (¾
2
0
(N )).F igure 2 d epic ts
¹
¾
2
(N ) (d otted line) w henN increases. Asit c anb e seen, there are valuesof¾
2
0
and N
suc h that perf
ec t inf
ormationsharing oc c ursand im pairsmarket liquid ity (allthe values
b elow the d otted line and ab ove the plainline).
2 0
Notic e that the market d epth isrelated to the b id -ask spread .Ac tually a b uy ord er of
size q pushesthe pric e upw ard b y ¸ q w hereasa sellord er ofthe sam e siz e pushesthe pric e
d ow nw ard b y ¸ q.Hence
s(q) = p(q)
¡p(¡q) = 2 ¸q;
c anb e interpreted asthe b id -askspread f
or anord er ofsiz e q inour m od el(see M ad havan
(19 96)). T he spread increases w ith ¸. Ac c ord ingly the im pac t ofinf
orm ationsharing
onb id -ask spread sisamb iguous. Interestingly em piric alstud iesw hic h c om pare b id -ask
spread s in°oor-b ased trad ing system s and autom ated trad ing system shave not f
ound
that spread sw ere system atic ally low er inone trad ingvenue.For instance,severalstud ies
(K of
m anand M oser (199 7), P irrong (199 6) and Shyy and Lee (19 95)) have c om pared
the b id -ask spread s onLIF F E (w henit w as a °oor market) and DT B (anautom ated
20
Forlargevalues ofN ,thedi®erence(¹
¾
2
0
(N )
¡¾
¤2
0
(N ))becomes smallerandsmallerbutis neverzero.
T hatis even forN large, there are values for¾
2
0
such thatperfectinformation sharingtakes place and
impairs marketdepth.
2 0
trad ingsystem ) f
or the sam e sec urity(nam elythe G erm anB und f
uturesc ontrac t).K of
m an
and M oser (19 97) ¯nd that spread sare equalinthe tw o m arkets; P irrong (199 6) reports
narrow er spread sonDT B w hereasShyy and Lee (19 95) ¯nd sm aller spread sonLIF F E .
InApril1997, the T oronto Stoc k E xc hange c losed its trad ing °oor and introd uc ed an
elec tronic trad ingsystem .G ri± thset al.(19 98) c om pare b id -askspread sf
or stockslisted
onthe T oronto Stoc k E xc hange b ef
ore and af
ter the sw itc h to the autom ated trad ing
system .T hey d o not ¯nd signi¯c ant c hangesinquoted spread s.
F inally w e c onsid er the e®ec tsofinf
orm ationsharingonthe aggregate expec ted trad ing
c ostsf
or the liquid ity trad ers.T hese expec ted trad ingc ostsare
E(TC ) = E(~
x(p
¡~v)) =
E(~
x
B
(p
¡~v))
|
{
z
}
O rd e rs c
h an ne le d by B
+
E(~
x
0
(p
¡~v))
| {
z
}
O rd ers notc
h anne led by B
:
Inthe last expression,w e d istinguish b etw eenthe expec ted trad ingc ostsf
or the liquid ity
trad ersw ho send their ord ersto b roker B and the expec ted trad ing c ostsf
or those w ho
d o not.U singLemm a 1,w e ob tainthat
E(~
x
B
(p
¡~v)) = E(~x
B
E(p
¡~v j~x
B
= x
B
)) = ¸E(~
x
2
B
(1+ b
1
+ b
2
+ a
3
)) = ¸
Ã
2 ¾
2
B
+ 3¾
2
´
6
¡
¾
2
B
+ ¾
2
´
¢
!
¾
2
B
;
and
E(~
x
0
(p
¡~v)) = ¸¾
2
0
:
Hence w e rew rite the expec ted trad ingc ostsas
E(TC ) =
¸g(¾
2
´
)¾
2
B
| {
z }
O rd ers c
h an nele d by B
+ ¸¾
2
0
;
w ith g(¾
2
´
) =
µ
2 ¾
2
B
+ 3¾
2
´
6
(
¾
2
B
+ ¾
2
´
)
¶
. T he ratio g(¾
2
´
) increasesw ith ¾
2
´
. Hence w heninf
orm ation
sharingim provesmarket d epth,it also d ec reasesthe expec ted trad ingc ostsf
or al
lliquid ity
trad ers: (1) the liquid itytrad ersw hose ord ersare c hanneled through b roker B and (2 ) the
other liquid ity trad ers. For instance, w ith perf
ec t inf
orm ationsharing thisoc c ursw hen
¾
2
0
2 [¹¾
2
0
(N );¾
¤2
0
(N )].
W heninf
orm ationsharing im pairsm arket d epth (increases¸), the expec ted trad ing
c ostsofthe liquid ity trad ersw ho d o not send their ord er to b roker B increase.How ever
the expec ted trad ing c ostsf
or the liquid ity trad ersw ho use B 'sservic esd ec line d espite
2 1
the d ec rease inm arket d epth.Ac tually inf
orm ationsharingincreasesc ompetitionam ong
trad ersprovid ingc ounter-partiesto B 'sc lients.T heref
ore a sm aller f
rac tionofthe ord ers
sub m itted b y B 'sc lientsmust b e exec uted against the m arket-m aker w henspec ulators
S and B share nonf
undam entalinf
orm ation(see E quation(6)). T he next proposition
show sthat the red uc tioninthe expec ted trad ing c ostsf
or B 'sc lientsalw aysd om inates
the increase inexpec ted trad ingc ostsf
or the other liquid ity trad ers.
P roposition5 : T he expec ted trad ing costs borne by the liquid ity trad ers are alw ays
sm aller w henthere isinf
ormationsharing.
T he trad inggam e isa zero-sum gam e inthism od el.T hisim pliesthat the expec ted trad ing
c ostsb orne b y liquid ity trad ersare equalto the spec ulatorsaggregate expec ted pro¯ts.
Let ¦
a
(¾
2
´
;¾
2
"
;N ) b e spec ulators' aggregate expec ted pro¯ts.W e have
E(T C ) = ¦
a
(¾
2
´
;¾
2
"
;N )
d ef
= ¦
S
+ ¦
B
+ (N
¡1)¦
i
;
w here ¦
i
(¾
2
´
;¾
2
"
;N ) isthe expec ted pro¯t ofa spec ulator w ho isnot part to the inf
orm ation
sharing agreem ent. R ec allthat a nec essary c onditionf
or inf
orm ationsharing isthat it
increasesthe joint expec ted pro¯tsofspec ulatorsB and S,i.e.¦
S
+ ¦
B
.Since inf
orm ation
sharingd ec reasesthe aggregate expec ted pro¯tsofallspec ulators,it f
ollow sthat the joint
expec ted pro¯t ofspec ulatorsi
2 f2 ;:::;N g d ec reases.T herefore,the c oncom itant d ec rease
intrad ingc ostsf
or liquid ity trad ersand increase intotalexpec ted pro¯tsf
or spec ulators
S and B oc c ur at the expense ofthe spec ulatorsw ho d o not share inf
orm ation.O b serve
that thisc annot happenw henthere isa single f
undamentalspec ulator (N = 1).Inf
ac t
inthisc ase, it ispossib le to show that there are no valuesf
or the param etersf
or w hich
inf
orm ationsharingisoptim alf
or B and S.
O verallthe resultsofthissec tionshow how inf
orm ationsharingonthe °oor c anim prove
the quality of°oor-b ased m arketsalong severald im ensions. Inf
orm ationsharing m akes
pric e more inf
orm ative,lessvolatile and f
ostersc om petitionb etw een°oor b rokers,so that
ultim ately the aggregate trad ingc ostsb orne b y the trad ersw ithout anac c essto the °oor
are low er.
2 2
5 Concl
usion
Inthispaper w e have analyz ed pre-trad e inf
orm ationsharing b etw eentw o tw o trad ers
endow ed w ith d i®erent types ofinf
orm ation, nam ely f
undam entalor non-f
undam ental
inf
orm ation.W e ¯nd that there are c asesinw hic h the tw o trad ersare b etter o® sharing
their inf
orm ation.Inf
orm ationsharing im provespric e d iscovery and d ec reasesvolatility.
W e also show that inf
ormationsharing d ec reases the aggregate expec ted trad ing c osts
b orne b y liquid ity trad ers.F inally the e®ec t ofinf
orm ationsharingonm arket d epth and
b id -ask spread sisamb iguous.
F loor-b ased trad ing systems are d esigned insuc h a w ay that they greatly f
ac ilitate
inf
orm ationsharing am ong °oor b rokers. O verallour resultsshow how thisf
eature c an
im prove their perf
ormance.Aninterestingquestionisw hether the b ene¯tsb rought up b y
inf
orm ationsharingare outw eighted b yinherent d isad vantagesof°oor-b ased system s(such
aslac k oftransparency or larger operatingc osts).T hisissue islef
t f
or f
uture researc h.
2 3
R ef
erences
[1] Ad m atiA.,and P °eid erer P .(1986),\A M onopolistic M arket f
or Inf
orm ation",J our-
nalofE conom ic T heory,39,4 0 0 {4 38.
[2 ] Ad m atiA.,and P °eid erer P .(1988),\Sellingand T rad ingonInf
orm ationinF inancial
M arkets",Am ericanE conomic R eview ,78(2 ),9 6{10 3.
[3] AllenF .(19 90 ),\T he M arket f
or Inf
orm ationand the O riginofF inancialInterm ed i-
ation",J ournalofF inancialInterm ed iation,1,3{30 .
[4 ] B enab ou, R .and Laroque, M .(1992 ), \U sing privileged inf
orm ationto m anipulate
m arkets: insid ers,gurusand c red ib ility",Quarterly J ournalofE conomic s,92 1{9 58.
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J .,and W ilhelm W .
J .(19 92 ), \W hat'sspec ialab out the
spec ialist ?",J ournalofF inancialE conom ic s,32 ,61{86.
[6] B hattacharya and P °eid erer (19 85), \Delegated portf
olio m anagement", J ournalof
E conom ic T heory,36,1{2 5.
[7] Chakravarty,S.and Sarkar,A.(2 0 0 0 ),\A M od elofB roker'strad ingw ith Applic ations
T o O rd er F low Internaliz ation",f
orthc om inginR eview ofF inancialE conomic s.
[8] Coval, J .and Shumw ay, T .(199 8), \Issound just noise", W orking paper, U niversity
ofM ichigan.
[9] Dom ow itz , Iand Steil, B .(1999 ), \Autom ation, trad ing c ostsand the struc ture of
the Sec uritiesT rad ing Industry", B rookings-W hartonP apersonF inancialServices,
2 ,33-9 2 .
[10 ] F ishm anM .and Hagerty K .(19 95), \T he Incentive to SellF inancialM arket Inf
or-
m ation",J ournalofF inancialInterm ed iation,4 ,95{115.
[11] F ishm an,M .and F .Longsta® (19 92 ),\DualT rad inginFuturesm arkets",J ournalof
F inance,4 7,64 3{669.
[12 ] G ri± ths, M .
, Smith, B .
, T urnbull, A.and R .W hite (1998), \Inf
orm ationF low sand
O penO utc ry: E vid ence ofIm itationT rad ing", J ournalofInternationalF innac ial
M arkets, Institutionsand M oney,8,10 1{116.
2 4
[13] Harris(2 0 0 0 ), L., \F loor versusautom ated trad ing systems: a survey ofthe issues",
LHarris.U SC.
ed u/Ac rob at/°oor.
[14 ] Hasb rouc k, J ., So¯anos, G .and Soseb ee, D.(199 3), \NY SE System sand T rad ing
P roc ed ures",NY SE W orkingP aper,93-0 1.
[15] K of
m an,P .and M oser,J .(19 97),\Spread s,inf
orm ation°ow sand transparencyac ross
trad ingsystems",Applied F inancialE conom ic s,7,2 81{2 94 .
[16] K yle A.S.(1985), \Continuous Auc tions and Insid er T rad ing", E conom etrica, 6,
1315{1335.
[17] M ad havan,A.(1996),\Sec urity pric esand m arket transparency",J ournalofF inan-
c ialInterm ed iation,5,2 55{2 83.
[18] M ad rigalV.(199 6),\Non-Fundam entalSpec ulation",J ournalofF inance,51(2 ),553{
576.
[19] P irrong, C.(199 6), \M arket liquid ity and d epth onc om puteriz ed and openoutc ry
trad ing system s: a c omparisonofDT B and LIF F E B und c ontrac ts", J ournalofFu-
turesM arkets,16,519{54 3.
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[2 2 ] Sarkar, A.and W u, L.(199 9) \Con°ic t ofinterestsand exec utionquality off
utures
°oor trad ers",W orkingP aper,New -Y ork F E D.
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orm ationasym m etry in
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uturesm arkets: LIF F E vs.DT B ",J ournalofFuturesM arkets,15,87-99 .
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, and W erner I.(19 97), \T he trad es ofNY SE F loor B rokers", NY SE
W orkingP aper 9 7-0 4 .
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rom the G erm anStoc k
M arket",W orkingP aper CR 69 0 ,G roupe HE C.
2 5
[2 6] VivesX.(199 5),\T he Speed ofInf
orm ationR evelationina F inancialM arket M ec ha-
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U niversity.
2 6
6 Append ix
P roofofLem m a 1
Step1: T he optim altrad in
g strategy f
or sp ec ul
ator S.Let y
S
= (~
v;^
v; ^
x) b e the
inf
orm ationset ofspec ulator S.T he latter c hooseshism arket ord er,Q
S
,so asto m axim iz e
hisexpec ted pro¯t
¼
S
(y
S
) = E(Q
S
(~
v
¡p(~
O ))
jy
S
):
T he ¯rst ord er c onditionyields
Q
S
(y
S
) =
(~
v
¡¹)¡¸ £E
h
Q
B
(y
B
) +
P
j= N
j= 2
Q
i
(~
v) + ~
x
0
+ ~
x
B
jy
S
i
2 ¸
:
(9 )
Notic e that
E
¡
Q
i
(~
v)
jy
S
¢
= a
0
(~
v
¡¹);
and
E
¡
Q
B
(y
B
)
jy
S
¢
= b
1
E (~
x
B
j^
x) + b
2
^
x + b
3
(^
v
¡¹ );
and
E (~
x
B
j^
x) =
¾
2
B
^
x
¾
2
B
+ ¾
2
´
:
Sub stitutingthese expressionsinE quation(9) yields
Q
S
(y
S
) =
(~
v
¡¹ )
2 ¸
¡
1
2
£
·
(N
¡1)a
0
(~
v
¡¹) + b
3
(^
v
¡¹ )+ (b
1
+ 1)
¾
2
B
¾
2
B
+ ¾
2
´
^
x + b
2
^
x
¸
=
µ
1
2 ¸
¡
(N
¡1)a
0
2
¶
(~
v
¡¹)¡
b
3
2
(^
v
¡¹ )¡
1
2
µ
(b
1
+ 1)
¾
2
B
¾
2
B
+ ¾
2
´
+ b
2
¶
^
x:
Hence,
a
1
=
µ
1
2 ¸
¡
(N
¡1)a
0
2
¶
a
2
=
¡
b
3
2
a
3
=
¡
1
2
µ
(b
1
+ 1)
¾
2
B
¾
2
B
+ ¾
2
´
+ b
2
¶
Step 2 : T he optim altrad ingstrategy f
or spec ul
ator i,i
6
= S.
2 7
Spec ulator ic hooseshismarket ord er,Q
i
,so asto m axim iz e hisexpec ted pro¯t
¼
i
(v) = E(Q
i
(~
v
¡p(~
O ))
j~v = v):
T he ¯rst ord er c onditionyields
Q
i
(~
v) =
(~
v
¡¹)¡¸ £E
h
Q
S
(y
S
) +
P
j= N
j= 2
Q
j
(~
v) + Q
B
(y
B
) + ~
x
j~v = v
i
¸
(10 )
W e f
oc usonsymm etric trad ing strategiesf
or allthe spec ulatorsi
6
= S. T hisim poses
Q
j
(~
v) = Q
i
(~
v);
8j6
= i.Sub stitutingQ
j
b y Q
i
inE quation(10 ) yields
Q
i
(~
v) =
(~
v
¡¹)
N ¸
¡
1
N
£
¡
E
£
Q
S
(y
S
)
j~v
¤
+ E
£
Q
B
(y
B
)
j~v = v
¤¢
:
(11)
Furthermore
E
¡
Q
S
(y
S
)
j~v = v
¢
= (a
1
+ a
2
)(~
v
¡¹);
and
E
¡
Q
B
(y
B
)
j~v = v
¢
= b
3
(~
v
¡¹ ):
Consequently
Q
i
(~
v) =
µ
1
N ¸
¡
(a
1
+ a
2
+ b
3
)
N
¶
(~
v
¡¹ ):
(12 )
W e d ed uc e that
a
0
=
1
N ¸
¡
(a
1
+ a
2
+ b
3
)
N
:
(13)
Step 3: T he optim altrad ingstrategy f
or sp ec ul
ator B .W e d enote y
B
= (~
x
B
;^
v; ^
x),
the inf
ormationset ofspec ulator B .She c hoosesher market ord er,Q
B
,so asto m axim iz e
¼
B
(y
B
) = E(Q
B
(~
v
¡p(~
O ))
jy
B
):
2 8
T he ¯rst ord er c onditionyields
Q
B
(y
B
) =
E (~
v
j^
v)
¡¹ ¡¸ £E
·
Q
S
(y
S
) +
N
P
i= 2
Q
i
(~
v) +
P
x
i
jy
B
¸
2 ¸
=
E (~
v
j^
v)
¡¹ ¡¸ £E
£
Q
S
(y
S
) + (N
¡1)Q
i
(~
v) + ~
x
jy
B
¤
2 ¸
:
W e notic e that
E
¡
Q
S
(y
S
)
jy
B
¢
= a
1
E (~
v
¡¹ j^
v) + a
2
(^
v
¡¹)+ a
3
^
x;
and
E
¡
Q
i
(~
v)
jy
B
¢
= a
0
E (~
v
¡¹ j^
v);
and that
E (~
v
¡¹ j^
v) =
¾
2
v
¾
2
v
+ ¾
2
"
(^
v
¡¹ ):
Sub stituting these expressionsinthe ¯rst ord er c onditionf
or Spec ulator B yields(af
ter
som e algeb ra)
Q
B
(y
B
) =
¡
~
x
B
2
¡
a
3
2
^
x +
1
2 ¸
µ
¾
2
v
¾
2
v
+ ¾
2
"
¡¸a
2
¡¸ (a
1
+ (N
¡1)a
0
)
¾
2
v
¾
2
v
+ ¾
2
"
¶
(^
v
¡¹ ):
(14 )
Hence,
b
1
=
¡
1
2
;
b
2
=
¡
a
3
2
;
b
3
=
1
2 ¸
µ
¾
2
v
¾
2
v
+ ¾
2
"
¡¸a
2
¡¸ (a
1
+ (N
¡1)a
0
)
¾
2
v
¾
2
v
+ ¾
2
"
¶
:
Steps1 to 3 give us9 equationsw ith 9 unknow ns(a
1
, a
2
etc ..
.). Solving thissystem of
2 9
equationsyield
a
1
=
3(¾
2
v
+ ¾
2
"
)
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
;
a
2
=
¡
¾
2
v
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
a
3
=
¡
¾
2
B
3
¡
¾
2
B
+ ¾
2
´
¢;
a
0
=
2 ¾
2
v
+ 3¾
2
"
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
;
b
1
=
¡
1
2
;
b
2
=
¾
2
B
6
¡
¾
2
B
+ ¾
2
´
¢;
b
3
=
2 ¾
2
v
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
;
Step 4 .Com putationof¸ .R ec allthat
p(O ) = E(~
v
j~
O = O ):
G ivenspec ulators' trad ingrules,
O = Q
S
(y
S
) + (N
¡1)Q
i
(~
v) + Q
B
(y
B
) + ~
x
= (a
1
+ (N
¡1)a
0
)(~
v
¡¹ )+ (a
2
+ b
3
)(^
v
¡¹ )+ (a
3
+ b
2
) ^
x + (b
1
+ 1) ~
x
B
+ ~
x
0
:
Hence ~
O isnorm ally d istrib uted ,w ith m eanzero.Consequently
p(O ) = ¹ + ¸ O ;
w ith
¸ =
C ov(~
v; ~
O )
V ar( ~
O )
:
(15)
Now
c
ov
³
~
v; ~
O
´
= (a
1
+ (N
¡1)a
0
+ a
2
+ b
3
)¾
2
v
=
(2 ¾
2
v
(N + 1) + 3N ¾
2
"
)¾
2
v
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
;
(16)
30
and
V ar (O ) =
(a
1
+ (N
¡1)a
0
)
2
¾
2
v
+ (a
2
+ b
3
)
2
¡
¾
2
v
+ ¾
2
"
¢
+ 2 (a
1
+ (N
¡1)a
0
)(a
2
+ b
3
)¾
2
v
+ (a
3
+ b
2
)
2
¡
¾
2
B
+ ¾
2
´
¢
+ (b
1
+ 1)
2
¾
2
B
+ 2 (a
3
+ b
2
)(b
1
+ 1)¾
2
B
+ ¾
2
0
=
(a
1
+ (N
¡1)a
0
+ a
2
+ b
3
)
2
¾
2
v
+
µ
b
3
2
¶
2
¾
2
"
+
µ
a
3
2
+
1
2
¶
2
¾
2
B
+
³a
3
2
´
2
¾
2
´
+ ¾
2
0
=
¾
2
v
(2 ¾
2
v
(N + 1) + 3N ¾
2
"
)
2
+ ¾
2
v
¾
2
"
(¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
))
2
¡
5¾
4
B
36
¡
¾
2
B
+ ¾
2
´
¢+
¾
2
B
4
+ ¾
2
0
:
W e d ed uc e that
¸ =
6
q
¾
2
v
¡
¾
2
B
+ ¾
2
´
¢
(4 (N + 1)¾
4
v
+ (12 N + 5)¾
2
v
¾
2
"
+ 9N ¾
4
"
)
(2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
q¡
¾
2
B
¡
4 ¾
2
B
+ 9¾
2
´
¢
+ 36¾
2
0
¡
¾
2
B
+ ¾
2
´
¢¢:
(17)
P roofofLem m a 2
W e w rite the equilib rium value of¸ inthe f
ollow ingw ay:
¸
¡
¾
2
"
;¾
2
´
¢
=
6
p
¾
2
v
(4 (N + 1)¾
4
v
+ (12 N + 5)¾
2
v
¾
2
"
+ 9N ¾
4
"
)
(2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
£
q
¾
2
B
+ ¾
2
´
q
¾
2
B
¡
4 ¾
2
B
+ 9¾
2
´
¢
+ 36¾
2
0
¡
¾
2
B
+ ¾
2
´
=
6
£¸
1
¡
¾
2
"
¢
£¸
2
¡
¾
2
´
¢
:
It f
ollow sthat
@¸
¡
¾
2
"
;¾
2
´
¢
@¾
2
´
=
6
£¸
1
¡
¾
2
"
¢
£
@¸
2
¡
¾
2
´
¢
@¾
2
´
=
¡
15
£¸
1
(¾
2
"
)
£(¾
2
B
)
2
q
¾
2
B
+ ¾
2
´
¡
¾
2
B
¡
4 ¾
2
B
+ 9¾
2
´
¢
+ 36¾
2
0
¡
¾
2
B
+ ¾
2
´
¢¢
3
2
< 0 ;
@¸
¡
¾
2
"
;¾
2
´
¢
@¾
2
"
=
6
£¸
2
¡
¾
2
´
¢
£
@¸
1
(¾
2
"
)
@¾
2
"
=
6
£¸
2
¡
¾
2
´
¢
£¾
4
v
(3(7N
¡5)¾
2
"
+ 2 (5N
¡2 )¾
2
v
)
2 (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
2
p
¾
2
v
(4 (N + 1)¾
4
v
+ (12 N + 5)¾
2
v
¾
2
"
+ 9N ¾
4
"
)
> 0 :
31
W e also ob serve that
lim
¾
2
"
! 1
¸
¡
¾
2
"
;¾
2
´
¢
=
6
£¸
2
¡
¾
2
´
¢
£
p
N ¾
2
v
(N + 1)
;
lim
¾
2
´
! 1
¸
¡
¾
2
"
;¾
2
´
¢
=
2
£¸
1
¡
¾
2
"
¢
£
1
p
¾
2
B
+ 4 ¾
2
0
:
Consequently,
¸(
1 ;1 ) = lim
¾
2
´
! 1
¾
2
"
! 1
¸
¡
¾
2
"
;¾
2
´
¢
= 6
£
1
p
9¾
2
B
+ 36¾
2
0
£ lim
¾
2
"
! 1
¸
1
¡
¾
2
"
¢
=
2
p
N ¾
2
v
(N + 1)
p
¾
2
B
+ 4 ¾
2
0
:
(18)
P roofofLem m a 3
W e d enote b y ¼
j
(y
j
), spec ulator j'sexpec ted pro¯t givenhisinf
orm ationset y
j
prior to
trad ingat d ate 1 and b y¦
j
(¾
2
´
;¾
2
"
;N ),hisex-ante expec ted pro¯t,that isb ef
ore ob serving
inf
orm ation.Notic e that
¼
j
(y
j
) = Q
j
£E(~v ¡¹ ¡¸ ~x ¡¸Q
¡j
¡¸Q
j
jy
j
):
(19 )
T he ¯rst ord er c onditionf
or spec ulator jim poses(see the proofofLem m a 1) that
2 ¸ Q
j
= E(~
v
¡¹ ¡¸ ~x ¡¸Q
¡j
jy
j
):
(2 0 )
Hence,w e d ed uc e f
rom E quations(19 ) and (2 0 ) that ¼
j
(y
i
) = ¸(Q
j
)
2
.It f
ollow sthat
¦
j
= E(¼
j
(y
j
)) = ¸
£V ar(Q
j
):
T hisim pliesthat
¦
S
(¾
2
´
;¾
2
"
;N ) = ¸
¡
a
2
1
V ar~
v + a
2
3
V ar^
x
1
+ a
2
2
V ar^
v + 2 a
1
a
2
c
ov (~
v;^
v)
¢
;
w hich yield (usingthe expressionsf
or a
1
,a
2
and a
3
)
¦
S
(¾
2
´
;¾
2
"
;N ) =
Ã
¾
2
v
(¾
2
v
+ ¾
2
"
)(4 ¾
2
v
+ 9¾
2
"
)
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
2
+
¸¾
4
B
9
¡
¾
2
B
+ ¾
2
´
¢
!
:
32
W e d e¯ne
¦
S
nf
d ef
=
¸ ¾
4
B
9
¡
¾
2
B
+ ¾
2
´
¢;
and
¦
S
f
d ef
=
µ
¾
2
v
(¾
2
v
+ ¾
2
"
)(4 ¾
2
v
+ 9 ¾
2
"
)
¸ (2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
2
¶
:
W e proc eed exac tly inthe same w ay f
or spec ulator B .
P roofofP roposition2
T he f
ollow inglem m a isusef
ulf
or the proof
.
Lem m a 4 : Inabsence ofinformationsharing, spec ulator S hasa larger expec ted pro¯ t
thanspec ulator B (¦
B
(
1 ;1 ;N ) ·¦
S
(
1 ;1 ;N )) i®
¾
2
0
¸
(N
¡1)
4 + (N
¡1)
:
P roof
: W e have
¦
B
(
1 ;1 ;N ) =
¸(
1 ;1 )¾
2
B
4
;
(2 1)
and
¦
S
(
1 ;1 ;N ) =
1
¸ (
1 ;1 )(N + 1)
2
:
(2 2 )
U singE quation(18) (proofofLem ma 2 ) w e ob tainthat ¦
B
(
1 ;1 ;N ) ·¦
S
(
1 ;1 ;N ) i®
¾
2
0
>
(N
¡1)¾
2
B
4
:
T henthe result f
ollow sf
rom the f
ac t that ¾
2
B
= 1
¡¾
2
0
.
W henthere isperf
ec t inf
orm ationsharing,spec ulatorsB and Shave the sam e expec ted
33
pro¯tsgivenb y
¦
S
(0 ;0 ;N ) = ¦
B
(0 ;0 ;N ) =
1
¸ (0 ;0 )(N + 2 )
2
+
¸(0 ;0 )¾
2
B
9
:
(2 3)
It f
ollow sthat perf
ec t inf
orm ationsharingispossib le i®
1
¸(0 ;0 )(N + 2 )
2
+
¸ (0 ;0 )¾
2
B
9
¸M axf¦
B
(
1 ;1 ;N );¦
S
(
1 ;1 ;N )g:
(2 4 )
Case 1.¾
2
0
¸
(N
¡1)
4 + (N
¡1)
:Inthisc ase,usingLemm a 4 ,w e c anrew rite Condition(2 4 ) as
1
¸(0 ;0 )(N + 2 )
2
+
¸(0 ;0 )¾
2
B
9
¸¦
S
(
1 ;1 ;N );
w hich yields(usingE quation(2 2 )),
1
¸ (0 ;0 )(N + 2 )
2
+
¸(0 ;0 )¾
2
B
9
¸
1
¸(
1 ;1 )(N + 1)
2
(2 5)
It f
ollow sf
rom the expressionof¸ (inthe proofofLem m a 2 ) that
¸(0 ;0 ) =
3
p
N + 1
(N + 2 )
p
¾
2
B
+ 9¾
2
0
;
and ¸(
1 ;1 ) isgivenb y equation(18).U sing these expressionsand the fac t that ¾
2
B
=
1
¡¾
2
0
,w e rew rite (af
ter som e algeb ra) E quation(2 5) as
µ
(N + 1)
(N + 2 )
¶
G (N ;¾
2
0
)
¸0 ;
w ith
G (N ;¾
2
0
) =
"
N + 1
N + 2
+
(N + 1)
2
(1
¡¾
2
0
)
(N + 2 )(1 + 8¾
2
0
)
¡
3
p
(N + 1)(1 + 3¾
2
0
)
2
p
N (1 + 8¾
2
0
)
#
:
Notic e that G (N ;:) d ec reasesw ith ¾
2
0
.Furtherm ore G isstric tly positive f
or ¾
2
0
=
(N
¡1)
4 + (N
¡1)
and negative f
or ¾
2
0
= 1.W e c onclud e that there existsa c uto® ¾
¤2
0
(N )
2 (
(N
¡1)
4 + (N
¡1)
;1) suc h
that Condition(2 5) issatis¯ed i® ¾
2
0
· ¾
¤2
0
(N ). T hisc uto® isim plic itly d e¯ned asthe
solutionof
G (N ;¾
2
0
) = 0 :
(2 6)
34
AsG (:;:) increasesw ith N and d ec reasesw ith ¾
2
0
, w e d ed uc e that ¾
2
¤
0
(N ) increasesw ith
N .
Case 2 .¾
2
0
<
(N
¡1)
4 + (N
¡1)
:Inthisc ase,usingLemm a 4 ,w e c anrew rite Condition(2 4 ) as
1
¸ (0 ;0 )(N + 2 )
2
+
¸(0 ;0 )¾
2
B
9
¸¦
B
(
1 ;1 ;N );
w hich yields(usingE quation(2 1)),
1
¸ (0 ;0 )(N + 2 )
2
+
¸(0 ;0 )¾
2
B
9
¸
¸(
1 ;1 )¾
2
B
4
(2 7)
U sing the expressionsf
or ¸ (0 ;0 ) and ¸(
1 ;1 ), after som e m anipulations, w e rew rite the
previousc onditionas
F (N ;¾
2
0
)
d ef
=
Ã
3(N + 2 )
p
N (1 + 8¾
2
0
)
2
p
(N + 1)(1 + 3¾
2
0
)
¡(N + 1)
!
(1
¡¾
2
0
)
1 + 8¾
2
0
¡1 ·0 :
W e ob serve that F (N ;:) d ec reasesw ith ¾
2
0
. Furtherm ore F > 0 f
or ¾
2
0
= 0 and F < 0
f
or ¾
2
0
=
(N
¡1)
4 + (N
¡1)
.It f
ollow sthat there existsa c uto® ¾
2
0
(N )
2 (0 ;
(N
¡1)
4 + (N
¡1)
) suc h that f
or
¾
2
0
¸¾
2
0
(N ),Condition(2 4 ) issatis¯ed .T hisc uto® isim plic itly d e¯ned asthe solutionof
F (N ;¾
2
0
) = 0 :
AsF (:;:) increasesw ith N and d ec reasesw ith ¾
2
0
, w e d ed uc e that ¾
2
0
(N ) increasesw ith
N .Furtherm ore w e have
0 < ¾
2
0
(N ) <
(N
¡1)
4 + (N
¡1)
< ¾
2
¤
0
(N ) < 1:
P roofofP roposition3
Step 1: P ric esare m ore in
f
orm ative w henthere isinf
orm ationsharin
g.R ec all
that ~
v and ~
p are norm ally d istrib uted and that ~
p(O ) = ¹ + ¸O .T heref
ore
V ar(~
v
j~p(O ) = p) = ¾
2
v
¡
C ov
2
(~
v; ~
O )
V ar( ~
O )
:
U singE quations(15) and (16) w hic h appear inthe proofofLem m a 1,w e ob tainthat
35
V ar(~
v
j~p(O ) = p) = ¾
2
v
¡¸C ov(~v; ~
O ) = ¾
2
v
¡
(2 ¾
2
v
(N + 1) + 3N ¾
2
"
)¾
2
v
(2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
:
It isim m ed iate that V ar(~
v
j~
p(O ) = p) increasesw ith ¾
2
"
and d oesnot d epend on¾
2
´
.T his
m eansthat inf
orm ationsharing (a d ec rease in¾
2
"
and ¾
2
´
) m akesequilib rium pric esm ore
inf
orm ative.
Step 2 : P ric esare l
essvol
atil
e w henthere isin
f
orm ationsharin
g.
O b serve that
V ar(~
v
¡p) = E(E((~v ¡p)
2
j~p = p)):
As~
p = E(~
v
j~p),the previousequality im pliesthat
V ar(~
v
¡p) = E(V ar(~v j~p = p)):
F inally since ~
v and ~
p are norm ally d istrib uted ,V ar(~
v
j~p = p) isc onstant so that
V ar(~
v
¡p) = V ar(~v j~
p = p):
Hence pric esare lessvolatile w henthere isinf
orm ationsharing since pric esare more in-
f
orm ative inthisc ase.
P roofofP roposition4
Consid er the f
ollow ingratio
H (N ;¾
2
0
) =
¸(0 ;0 )
¸ (
1 ;1 )
:
P erf
ec t inf
orm ationsharingimprovesm arket liquid ity ifand only if
H (N ;¾
2
0
) < 1:
U singthe expressionf
or ¸ giveninthe proofofLem m a 2 ,w e ob tain
H (N ;¾
2
0
) =
3(N + 1)
p
(N + 1)(1 + 3¾
2
0
)
2 (N + 2 )
p
N (1 + 8¾
2
0
)
:
36
It isim m ed iate that H (N ;:) d ec reasesw ith ¾
2
0
.Furtherm ore H (N ;1) < 1 and H (N ;0 ) > 1.
T heref
ore there existsa threshold ¹
¾
2
0
(N ) suc h that H < 1 i® ¾
2
0
> ¹
¾
2
0
(N ).T histhreshold
solves
H (N ;¾
2
0
) = 1:
Solvingthisequation,w e d ed uc e that
¹
¾
2
0
(N ) =
1
¡h
2
(N )
8h
2
(N )
¡3
;
w here h (N ) =
2 (N + 2 )
p
N
3(N + 1)
p
N + 1)
< 1.Ash (N )
¸2 =3,w e have ¹¾
2
0
< 1.
P roofofP roposition5
T he expec ted trad ingc ostsf
or the liquid ity trad ersw henthere isinf
ormationsharingare
E (C T
e
) = ¸
Ã
6¾
2
0
¡
¾
2
B
+ ¾
2
´
¢
+
¡
2 ¾
2
B
+ 3¾
2
´
¢
¾
2
B
6
¡
¾
2
B
+ ¾
2
´
¢
!
:
U singthe expressionf
or ¸,w e rew rite thisequationas
E (C T
e
) =
p
¾
2
v
(4 (N + 1)¾
4
v
+ (12 N + 5)¾
2
v
¾
2
"
+ 9N ¾
4
"
)
¡
6¾
2
0
¡
¾
2
B
+ ¾
2
´
¢
+
¡
2 ¾
2
B
+ 3¾
2
´
¢
¾
2
B
¢
(2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
q¡
¾
2
B
+ ¾
2
´
¢£
¾
2
B
¡
4 ¾
2
B
+ 9 ¾
2
´
¢
+ 36¾
2
0
¡
¾
2
B
+ ¾
2
´
¢¤ :
W henthe b rokersd o not share their inf
orm ation,then
E (C T
ne
) =
E [(P(O )
¡~v)£~x]= ¸
n e
µ
¾
2
0
+
1
2
¾
2
B
¶
=
p
¾
2
v
N
(N + 1)
£
(2 ¾
2
0
+ ¾
2
B
)
p
¾
2
B
+ 4 ¾
2
0
:
W e d enote © the d i®erence b etw eenthe expec ted trad ingc ostsw henthere isinf
orm ation
sharingand w henthere isno inf
orm ationsharing.Hence
©
¡
N ;¾
2
"
;¾
2
´
¢
= E (C T
e
)
¡E (C T
ne
)
37
Straightf
orw ard m anipulationsshow that
p
¾
2
v
(4 (N + 1)¾
4
v
+ (12 N + 5)¾
2
v
¾
2
"
+ 9N ¾
4
"
)
(2 (N + 2 )¾
2
v
+ 3(N + 1)¾
2
"
)
<
p
¾
2
v
N
(N + 1)
(2 8)
Now c onsid er the f
ollow ingf
unction
Ã
¡
¾
2
´
¢
=
¡
6¾
2
0
¡
¾
2
B
+ ¾
2
´
¢
+
¡
2 ¾
2
B
+ 3¾
2
´
¢
¾
2
B
¢
2
¡
¾
2
B
+ ¾
2
´
¢£
¾
2
B
¡
4 ¾
2
B
+ 9¾
2
´
¢
+ 36¾
2
0
¡
¾
2
B
+ ¾
2
´
¢¤¡
(2 ¾
2
0
+ ¾
2
B
)
2
¾
2
B
+ 4 ¾
2
0
:
As¾
2
0
= 1
¡¾
2
B
,w e rew rite the previousequationas
Ã
¡
¾
2
´
¢
=
¡
6
¡
¾
2
B
+ ¾
2
´
¢
¡¾
2
B
¡
4 ¾
2
B
+ 3¾
2
´
¢¢
2
¡
¾
2
B
+ ¾
2
´
¢£
36
¡
¾
2
B
+ ¾
2
´
¢
¡¾
2
B
¡
32 ¾
2
B
+ 2 7¾
2
´
¢¤¡
(2
¡¾
2
B
)
2
4
¡3¾
2
B
:
O b serve that
à (0 ) =
¾
2
B
(
¡7+ 11¾
2
B
¡4 ¾
4
B
)
(9
¡8¾
2
B
)(4
¡3¾
2
B
)
< 0 ,since ¾
2
B
2 [0 ;1]
and
lim
¾
2
´
! 1
Ã
¡
¾
2
´
¢
= 0 :
and
Ã
0
¡
¾
2
´
¢
=
¾
4
B
¡
176¾
8
B
+ 14 4 ¾
6
B
¡
2 ¾
2
´
¡3
¢
¡72 ¾
2
B
¾
2
´
¡
5¾
2
´
¡7
¢
+ 9 ¾
4
B
¡
13¾
4
´
¡88¾
2
´
+ 2 8
¢
+ 2 52 ¾
4
´
¢
¡
¾
2
B
+ ¾
2
´
¢
2
£
36
¡
¾
2
B
+ ¾
2
´
¢
¡¾
2
B
¡
32 ¾
2
B
+ 2 7¾
2
´
¢¤
2
(2 9 )
Now w e rem ark that if¾
2
B
2
£
0 ;
2 1
2 2
¤
, thenÃ
0
¡
¾
2
´
¢
> 0 and theref
ore Ã
¡
¾
2
´
¢
< 0 . If
¾
2
B
2
£
2 1
2 2
;1
¤
,thenthere isa unique value of¾
2
´
suc h that Ã
0
= 0 .T hisvalue is
¹
¾
2
´
=
2 ¾
2
B
(2 2 ¾
2
B
¡2 1)
3(14
¡13¾
2
B
)
:
Hence à hasonly one extremum and thisextremum isa m inimum since
38
Ã
00
¡
¹
¾
2
´
¢
=
2 7(14
¡13¾
2
B
)
4
62 5¾
8
B
(2 ¾
2
B
¡1)
> 0 ;
W e d ed uc e that
8¾
2
´
and
8¾
2
B
,Ã
¡
¾
2
´
¢
< 0 .W e c onclud e that
¡
6¾
2
0
¡
¾
2
B
+ ¾
2
´
¢
+
¡
2 ¾
2
B
+ 3¾
2
´
¢
¾
2
B
¢
q¡
¾
2
B
+ ¾
2
´
¢£
¾
2
B
¡
4 ¾
2
B
+ 9¾
2
´
¢
+ 36¾
2
0
¡
¾
2
B
+ ¾
2
´
¢¤<
(2 ¾
2
0
+ ¾
2
B
)
p
¾
2
B
+ 4 ¾
2
0
:
(30 )
U singInequality(2 8) and Inequality(30 ),w e d ed uc e that ©
¡
N ;¾
2
"
;¾
2
´
¢
< 0 w hich m eans
that the expec ted trad ingc ostsare alw ayslow er w henthere isinf
orm ationsharing.
39
FIGURE 1: Is Perfect Information Sharing Possible?
0
0,1
0,2
0,3
0,4
0,5
0,6
0,7
0,8
0,9
1
2
5
10
15
20
25
30
35
40
45
50
Number of Fundamental Speculators
s
2 0
NO
YES
NO
σ
2
0
(N)
σ
2
0
*
(N)
FIGURE 2: Does Perfect Information Sharing Improve Liquidity?
0
0,1
0,2
0,3
0,4
0,5
0,6
0,7
0,8
0,9
1
2
5
10
15
20
25
30
35
40
45
50
Number of Fundamental Speculators
s
2
0
YES
NO
σ
2
0
(N)
σ
2
0
*
(N)