Discretionary liquidity trading, information production and market efficiency

•We endogenize both information production and liquidity trading.•A unique equilibrium exists, in which only parts of discretionary liquidity traders can satisfy their liquidity needs.•Strategic complementary effect occurs with the production of information by professionals.•Increases in the compens...

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Bibliographic Details
Published in:Finance research letters 2020-07, Vol.35, p.101299, Article 101299
Main Authors: Liu, Xia, Liu, Shancun, Qi, Zhen, Wen, Chunhui
Format: Article
Language:English
Subjects:
Complimentary effect
Information Efficiency
Information production
Market liquidity
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Summary:•We endogenize both information production and liquidity trading.•A unique equilibrium exists, in which only parts of discretionary liquidity traders can satisfy their liquidity needs.•Strategic complementary effect occurs with the production of information by professionals.•Increases in the compensation of discretionary liquidity traders and/or the number of professionals promote information production and enhance market liquidity and information efficiency at the cost of greater price volatility and even “breakdown” of the market. We analyze the professionals’ strategies of information production and the consequent market efficiency in the presence of discretionary liquidity trading. A unique equilibrium exists where only parts of discretionary liquidity traders can satisfy their liquidity needs. Instead of competition effect, strategic complementary effect occurs with the production of information by professionals. In particular, with discretionary liquidity trading, increases in the compensation of discretionary liquidity traders and/or the number of professionals promote information production and enhance market liquidity and information efficiency, although price volatility is amplified. This result suggests that regulators should open more access to information production for better market efficiency.
ISSN:1544-6123
1544-6131
DOI:10.1016/j.frl.2019.09.014