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Price formation in call auctions with insider information

Price formation in call auctions with insider information This study aims to investigate – theoretically and empirically – if call auctions incorporate asymmetric information into prices.Design/methodology/approachFirst, this study introduces a new model of price formation in a call auction with insider information. In this call auction model, insider trading gives rise to an asymmetric information component of transaction costs. Next, this study estimates the model using 20 stocks from Euronext Paris and investigates if the asymmetric information component is present.FindingsThe theoretical analysis reveals that call auctions incorporate asymmetric information into prices. The empirical analysis finds strong evidence for the asymmetric information component. Testable implications provide further support for the model.Practical implicationsCall auctions have recently been proposed as an alternative to continuous limit order book markets to overcome problems associated with high-frequency trading. However, it is still an open question whether call auctions efficiently aggregate asymmetric information. The findings of this study imply that call auctions facilitate price discovery and, therefore, are a viable alternative to continuous limit order book markets.Originality/valueThere is no generally accepted measure of trading costs for call auctions. Therefore, the measure introduced in this study is of great value to anyone who wants to quantify trading costs in call auctions, understand the determinants of trading costs in call auctions or compare trading costs and their components between continuous markets and call auctions. This study also contributes to the literature devoted to estimating the probability of information-based trading. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Studies in Economics and Finance Emerald Publishing

Price formation in call auctions with insider information

Studies in Economics and Finance , Volume 36 (3): 19 – Aug 8, 2019

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Publisher
Emerald Publishing
Copyright
© Emerald Publishing Limited
ISSN
1086-7376
DOI
10.1108/sef-02-2018-0066
Publisher site
See Article on Publisher Site

Abstract

This study aims to investigate – theoretically and empirically – if call auctions incorporate asymmetric information into prices.Design/methodology/approachFirst, this study introduces a new model of price formation in a call auction with insider information. In this call auction model, insider trading gives rise to an asymmetric information component of transaction costs. Next, this study estimates the model using 20 stocks from Euronext Paris and investigates if the asymmetric information component is present.FindingsThe theoretical analysis reveals that call auctions incorporate asymmetric information into prices. The empirical analysis finds strong evidence for the asymmetric information component. Testable implications provide further support for the model.Practical implicationsCall auctions have recently been proposed as an alternative to continuous limit order book markets to overcome problems associated with high-frequency trading. However, it is still an open question whether call auctions efficiently aggregate asymmetric information. The findings of this study imply that call auctions facilitate price discovery and, therefore, are a viable alternative to continuous limit order book markets.Originality/valueThere is no generally accepted measure of trading costs for call auctions. Therefore, the measure introduced in this study is of great value to anyone who wants to quantify trading costs in call auctions, understand the determinants of trading costs in call auctions or compare trading costs and their components between continuous markets and call auctions. This study also contributes to the literature devoted to estimating the probability of information-based trading.

Journal

Studies in Economics and FinanceEmerald Publishing

Published: Aug 8, 2019

Keywords: Transaction costs; Informational efficiency; Asymmetric information; Bayesian econometrics; D82; G14; C11

References