Economy – Quantitative Finance – Trading and Market Microstructure
Scientific paper
2008-07-08
Economy
Quantitative Finance
Trading and Market Microstructure
20 pages, 5 figures. Version to appear in the Proceedings of the Royal Society A
Scientific paper
An asymmetric information model is introduced for the situation in which there is a small agent who is more susceptible to the flow of information in the market than the general market participant, and who tries to implement strategies based on the additional information. In this model market participants have access to a stream of noisy information concerning the future return of an asset, whereas the informed trader has access to a further information source which is obscured by an additional noise that may be correlated with the market noise. The informed trader uses the extraneous information source to seek statistical arbitrage opportunities, while at the same time accommodating the additional risk. The amount of information available to the general market participant concerning the asset return is measured by the mutual information of the asset price and the associated cash flow. The worth of the additional information source is then measured in terms of the difference of mutual information between the general market participant and the informed trader. This difference is shown to be nonnegative when the signal-to-noise ratio of the information flow is known in advance. Explicit trading strategies leading to statistical arbitrage opportunities, taking advantage of the additional information, are constructed, illustrating how excess information can be translated into profit.
Brody Dorje C.
Davis Mark H. A.
Friedman Robyn L.
Hughston Lane. P.
No associations
LandOfFree
Informed Traders does not yet have a rating. At this time, there are no reviews or comments for this scientific paper.
If you have personal experience with Informed Traders, we encourage you to share that experience with our LandOfFree.com community. Your opinion is very important and Informed Traders will most certainly appreciate the feedback.
Profile ID: LFWR-SCP-O-268849