Information sharing among strategic traders - The role of disagreement (Job market paper)

When do competing traders, endowed with different pieces of fundamental information pertaining to a security’s payoff, exchange information before trading? I show that competing traders share information when they disagree enough with each other. Traders lose some competitive rents by sharing private information but with disagreement, they can engage in profitable belief arbitrage by “shorting” their competitor's signal. Disagreement makes the market more liquid, but full information sharing caps the liquidity benefits. Mediators (say, sell-side analysts or brokers) facilitate information sharing by aggregating and distributing information in an incentive compatible manner.

I study coordination games (eg. IPOs, currency attacks, bank runs) where players are uncertain about what others know, and analyze how this second order uncertainty can be useful for achieving coordination among agents. When agents face second order uncertainty, it is possible to design simple information structures with contagion where the policymaker's preferred action becomes uniquely rational. In a stylized bank run model, a bank manager allows perfect information when bank fundamentals are weak, but allows agents to be uncertain about the other agent's knowledge in all other scenarios. This provides a rationale for accounting conservatism in banking: all probable loan losses are recorded when they are discovered, while knowledge of investment gains are privately dispersed among agents.

We study a model of cash management using a portfolio of assets with varying degrees of liquidity. In our setting, the agent faces a probabilistic interim liquidity shock and chooses which assets to liquidate. Assets with high liquidation value are valuable in states when the liquidity shock is high or there is a scarcity of other liquid assets in the economy. The downsides of assets are protected by their expected terminal value, which delivers an option-like convex pricing rule with a single representative agent. The agent’s reservation price of a liquid asset is an American put option with strike price process given by the liquidation value in each period.

We study a search model of investors' asset trading, intermediated by financial institutions (such as PE funds) that are at risk of selling under pressure. The pressure can lead to the development of a secondary market, where intermediaries bail each other out of liquidity constraints. Counterintuitively, an increase in competing intermediaries can lead to an increase of each intermediary's value: the enhanced benefits of secondary trades can be so large as to dominate the reduction in value from narrower buy-sell spreads due to more intense competition. The market exhibits search externality; suppressing investors' direct trading can improve welfare. The paper provides a calibration to the corporate acquisition market.