Scandinavian Working Papers in Economics

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

No 2019/2: Strategic Insider Trading Equilibrium with a non-fiduciary market maker

Knut K. Aase () and Bernt Øksendal ()
Additional contact information
Knut K. Aase: Dept. of Business and Management Science, Norwegian School of Economics, Postal: NHH , Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway
Bernt Øksendal: Dept. of Mathematics, University of Oslo, Postal: University of Oslo , Department of Mathematics, P.O. Box 1053 Blindern, N-0316 Oslo, Norway

Abstract: The continuous-time version of Kyle's (1985) model 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 modest fee conditional of the order ow, the market maker is able to obtain a profit of the order of magnitude, and even better than, a perfectly informed insider. Our model also indicates why speculative prices are more volatile than predicted by fundamentals.

Keywords: Insider trading; asymmetric information; strategic trade; price distortion; non-fiduciary market maker; bid-ask spread; linear filtering theory; innovation equation

JEL-codes: G00

44 pages, First version: August 28, 2019. Revised: December 12, 2019.

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