TY - JOUR
T1 - Front-running dynamics
AU - Bernhardt, Dan
AU - Taub, Bart
N1 - Funding Information:
We thank Charlie Kahn and Burton Hollifield for helpful comments. We acknowledge financial support from the National Science Foundation, Research Grant #SES-0317706.
PY - 2008/1
Y1 - 2008/1
N2 - We integrate a monopolist dual trader into a dynamic model of speculation. In static settings, [J.-C. Rochet, J.-L. Vila, Insider trading without normality, Rev. Econ. Stud. 61 (1994), 131-152] establish an irrelevance result-expected equilibrium outcomes are the same whether the monopolist speculator sees liquidity trade or not; and Roell [Dual-capacity trading and market quality, J. Finan. Intermediation (1990), 105-124] shows that with multiple speculators, dual trading benefits liquidity traders. In dynamic settings, these results are reversed: a front-running speculator exploits knowledge of future liquidity trade, extracting greater profits by smoothing profit extraction intertemporally. Front running introduces positive serial correlation to order flow. Accordingly, market makers discount past order flow in prices, but prices retain the martingale property.
AB - We integrate a monopolist dual trader into a dynamic model of speculation. In static settings, [J.-C. Rochet, J.-L. Vila, Insider trading without normality, Rev. Econ. Stud. 61 (1994), 131-152] establish an irrelevance result-expected equilibrium outcomes are the same whether the monopolist speculator sees liquidity trade or not; and Roell [Dual-capacity trading and market quality, J. Finan. Intermediation (1990), 105-124] shows that with multiple speculators, dual trading benefits liquidity traders. In dynamic settings, these results are reversed: a front-running speculator exploits knowledge of future liquidity trade, extracting greater profits by smoothing profit extraction intertemporally. Front running introduces positive serial correlation to order flow. Accordingly, market makers discount past order flow in prices, but prices retain the martingale property.
KW - Dual trading
KW - Frontrunning
KW - Informed speculators
KW - Liquidity trade
KW - Private information
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U2 - 10.1016/j.jet.2007.05.005
DO - 10.1016/j.jet.2007.05.005
M3 - Article
AN - SCOPUS:37349064859
SN - 0022-0531
VL - 138
SP - 288
EP - 296
JO - Journal of Economic Theory
JF - Journal of Economic Theory
IS - 1
ER -