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Price distortions under coarse reasoning with frequent trade


Steiner, Jakub; Stewart, Colin (2015). Price distortions under coarse reasoning with frequent trade. Journal of Economic Theory, 159:574-595.

Abstract

We study the effect of frequent trading opportunities and categorization on pricing of a risky asset. Frequent opportunities to trade can lead to large distortions in prices if some agents forecast future prices using a simplified model of the world that fails to distinguish between some states. In the limit as the period length vanishes, these distortions take a particular form: the price must be the same in any two states that a positive mass of agents categorize together. Price distortions therefore tend to be large when different agents categorize states in different ways, even if each individual's categorization is not very coarse.

Abstract

We study the effect of frequent trading opportunities and categorization on pricing of a risky asset. Frequent opportunities to trade can lead to large distortions in prices if some agents forecast future prices using a simplified model of the world that fails to distinguish between some states. In the limit as the period length vanishes, these distortions take a particular form: the price must be the same in any two states that a positive mass of agents categorize together. Price distortions therefore tend to be large when different agents categorize states in different ways, even if each individual's categorization is not very coarse.

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Additional indexing

Other titles:Price distortions in high-frequency markets
Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Economics
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Economics and Econometrics
Uncontrolled Keywords:Categorization, bounded rationality, prices
Language:English
Date:1 September 2015
Deposited On:24 Sep 2019 12:51
Last Modified:31 Jul 2020 03:39
Publisher:Elsevier
ISSN:0022-0531
OA Status:Green
Publisher DOI:https://doi.org/10.1016/j.jet.2015.07.011

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