Information Asymmetries, Volatility, Liquidity and the Tobin Tax

Information asymmetries and trading costs, in a financial market model with dynamic information, generate a self-exciting equilibrium price process with stochastic volatility, even if news have constant volatility. Intuitively, new (constant volatility) information is released to the market at trading times that, due to traders’ strategic choices, differ from calendar times. This generates an endogenous stochastic time change between trading and calendar times, and stochastic volatility of the price process in calendar time. In equilibrium: price volatility is autocorrelated and is a non-linear function of number and volume of trades; the relative informativeness of number and volume of trades depends on the data sampling frequency; volatility, price quotes, tightness, depth, resilience, and trading activity, are jointly determined by information asymmetries and trading costs. Our closed form solutions rationalize a large set of empirical evidence and provide a natural laboratory for analyzing the equilibrium effects of a financial transaction tax.

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