Bid Ask Price Competition with Asymmetric Information Between Market Makers

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  • 1 January 2006
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      • Published in RePEc
Abstract
This paper studies the effect of asymmetric information on the price formation process in a quote-driven market. One market maker receives private information on the value of the quoted asset, and repeatedly competes with market makers who are uninformed. We show that despite the fact that the informed market maker's quotes are public, the market is never strong-form efficient with certainty until the last stage. We characterize a reputational equilibrium in which the informed market-maker influences and possibly misleads the uninformed market makers' beliefs. At this equilibrium, a price leadership effect arises, the informed market maker's expected payoff is positive and the rate of price discovery increases in the last stages of trade

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