A New Approach for the Continuous Time Kyle-Back Strategic Insider Equilibrium Problem

TL;DR

This paper introduces a novel stochastic control approach to the continuous-time Kyle-Back insider trading model, establishing the existence and uniqueness of equilibria via coupled FBSDEs, and broadening the understanding beyond traditional PDE methods.

Contribution

It provides the first uniqueness result for the equilibrium in the Kyle-Back model without Markovian restrictions, using coupled FBSDEs instead of PDEs.

Findings

All equilibria characterized by coupled forward-backward SDEs.

Unique equilibrium established for small time durations.

Set of insider values characterized by a level set of HJB equations.

Abstract

This paper considers a continuous time Kyle-Back model which is a game problem between an insider and a market marker. The existing literature typically focuses on the existence of equilibrium by using the PDE approach, which requires certain Markovian structure and the equilibrium is in the bridge form. We shall provide a new approach which is used widely for stochastic controls and stochastic differential games. We characterize all equilibria through a coupled system of forward backward SDEs, where the forward one is the conditional law of the inside information and the backward one is the insider's optimal value. In particular, when the time duration is small, we show that the FBSDE is wellposed and thus the game has a unique equilibrium. This is the first uniqueness result in the literature, without restricting the equilibria to certain special structure. Moreover, this unique equilibrium may not be Markovian, indicating that the PDE approach cannot work in this case. We next study the set value of the game, which roughly speaking is the set of insider's values over all equilibria and thus is by nature unique. We show that, although the bridge type of equilibria in the literature does not satisfy the required integrability for our equilibria, its truncation serves as a desired approximate equilibrium and its value belongs to our set value. Finally, we characterize our set value through a level set of certain standard HJB equation.