Strategic Trading and Welfare in a Dynamic Market

By Dimitri Vayanos
1996| Working Paper No. 1416

This paper studies a dynamic model of a financial market with N strategic agents. Agents receive random stock endowments at each period and trade to share dividend risk. Endowments are the only private information in the model. We find that welfare loss, defined as the fraction of the gains from trade lost due to strategic behavior, increases as the time between trades decreases. When the time between trades becomes very small, welfare loss is of order 1/N, and not 1/N2 as a static models of double auctions literature. The model is very tractable and closed-form solutions are obtained in a special case.