Stock Market Insider Trading in Continuous Time with Imperfect Dynamic Information

TL;DR

This paper models the equilibrium pricing in continuous-time stock markets with an insider possessing private information, analyzing strategies and market efficiency impacts, including non-Markovian equilibria where past information is re-evaluated.

Contribution

It provides a comprehensive characterization of optimal insider strategies and market maker pricing rules, including existence proofs for both Markovian and non-Markovian equilibria with closed-form solutions.

Findings

Unique Markovian equilibrium price process identified

Insider trading enhances market informational efficiency near dividend payments

Non-Markovian equilibria allow re-weighting of past information by market makers

Abstract

This paper studies the equilibrium pricing of asset shares in the presence of dynamic private information. The market consists of a risk-neutral informed agent who observes the firm value, noise traders, and competitive market makers who set share prices using the total order flow as a noisy signal of the insider's information. I provide a characterization of all optimal strategies, and prove existence of both Markovian and non Markovian equilibria by deriving closed form solutions for the optimal order process of the informed trader and the optimal pricing rule of the market maker. The consideration of non Markovian equilibrium is relevant since the market maker might decide to re-weight past information after receiving a new signal. Also, I show that a) there is a unique Markovian equilibrium price process which allows the insider to trade undetected, and that b) the presence of an insider increases the market informational efficiency, in particular for times close to dividend payment.