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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2016/8:
Insider trading with non-fiduciary market makers

Knut K. Aase () and Fr°ystein Gjesdal ()

Abstract: The single auction equilibrium of Kyle's (1985) is studied, in which market makers are not fiduciaries. They have some market power which they utilize to set the price to their advantage, resulting in positive expected profits. This has several implications for the equilibrium, the most important being that by setting a relatively modest "fee", the market maker is able to obtain a profit of the order of magnitude, and even better than, a perfectly informed insider. Our model indicates why speculative prices are more volatile than predicted by fundamentals. Noise traders may be uninformed, or partially informed. We analyze a situation where the market maker has private information as well as being non-fiduciary. In our model this leads to a more efficient market where the insider trades less and the market maker's profit increases.

Keywords: Insider trading; asymmetric information; strategic trade; correlated trade; price distortion; partially informed market maker; (follow links to similar papers)

JEL-Codes: G00; (follow links to similar papers)

49 pages, May 23, 2016

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