Discussion Papers, Department of Finance and Management Science, Norwegian School of Economics (NHH)
No 2007/24:
Strategic Insider Trading Equilibrium: A Forward Integration Approach
Knut K. Aase ()
, Terje Bjuland ()
and Bernt Øksendal ()
Abstract: The continuous-time version of Kyle’s (1985) model of
asset pricing with asymmetric information is studied, and generalized in
various directions, i.e., by allowing time-varying noise trading, and by
allowing the orders of the noise traders to be correlated with the
insider’s signal. From rather simple assumptions we are able to derive the
optimal trade for an insider; the trading intensity satisfies a
deterministic integral equation, given perfect inside information. We use a
new technique called forward integration in order to find the optimal
trading strategy. This is an extension of the stochastic integral which
takes account of the informational asymmetry inherent in this problem. The
market makers’ price response is found by the use of filtering theory. The
novelty is our approach, which could be extended in scope.
Keywords: Insider trading; asymmetric information; equilibrium; strategic trade; filtering theory; forward integration; (follow links to similar papers)
JEL-Codes: C00; G12; (follow links to similar papers)
27 pages, November 8, 2007
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