A Stationary Kyle Setup: Microfounding propagator models

TL;DR

This paper develops a stationary, micro-founded extension of the Kyle model, capturing continuous-time market dynamics with rational agents and asymmetric information, and linking volatility, fundamentals, and trading volume.

Contribution

It introduces a stationary Kyle setup derived from agent-based models, generalizing the classic Kyle model to continuous time without a terminal information revelation.

Findings

Compatible with universal price diffusion at small times

Exhibits non-universal mean-reversion at longer time scales

Provides a testable relation between volatility, fundamentals, and volume

Abstract

We provide an economically sound micro-foundation to linear price impact models, by deriving them as the equilibrium of a suitable agent-based system. Our setup generalizes the well-known Kyle model, by dropping the assumption of a terminal time at which fundamental information is revealed so to describe a stationary market, while retaining agents' rationality and asymmetric information. We investigate the stationary equilibrium for arbitrary Gaussian noise trades and fundamental information, and show that the setup is compatible with universal price diffusion at small times, and non-universal mean-reversion at time scales at which fluctuations in fundamentals decay. Our model provides a testable relation between volatility of prices, magnitude of fluctuations in fundamentals and level of volume traded in the market.