Week 4 - Information and Price Flashcards
What is meant by:
“Trading is a zero-sum game”
Means that the total gain of a winner exactly equals the losses of the loser
What are the trading returns?
Positive for winners:
Have a comparative advantage
Negative for losers:
Must receive other benefits from trade
What are the three broad categories of traders?
- Utilitarian Traders
- Profit Motivated Traders
- Futile Traders/Noise Traders
Describe a Utilitarian trader and their preferred market conditions
Defined:
Traders that trade for benefits other than profit
Preferred Conditions:
1. Liquid markets
2. Low transaction costs
Why do Utilitarian traders trade?
For reasons other than profit:
- Investment/divestment
- Risk-Sharing
- Asset Exchange
- Hedging
- Gambling
- Tax purposes
Describe Futile Traders / Noise Traders
Traders that attempt to make money but fail
Trade on information they believe to be “special”
Large quantities of noise traders can distort prices
Define profit motivated traders
Where do their earnings come from?
Traders that trade purely for profit
Profit primarily comes from utilitarian trader’s willingness to pay
+
futile/noise traders
What are the two subcategories of Profit motivated traders?
- Liquidity supplier
- Speculators
What are the two subcategories of Speculator traders?
- Informed Traders
- Parasitic Traders
What are the two categories of parasitic traders?
- Order anticipators
- Market manipulators
What are the three different types of informed traders?
- Value Traders
- News Traders
- Information-oriented technical traders
What are the three different types of “order anticipators”?
- Front Runners
- Quote matchers
- Sentiment-orientated technical traders
Describe parasitic traders
Parasitic traders:
- Act on information about other traders
- create information to fool others
Describe speculator traders
Speculator Traders:
Informed traders that expect conditional returns:
R_f + R_prem + R_info
- rational reasoning behind decisions
What are the two type of liquidity suppliers?
- Dealers
- Arbitragers
Describe this type of trader: Dealer
Dealers are a form of liquidity supplier
Profit = bid-ask spread
Describe this type of trader: Arbitrager
Dealers are a form of liquidity supplier
- buy + sell the same asset across different markets
- uphold the law of one price
What is the difference between speculators and gamblers?
Speculators are informed traders who collect, analyse and produce information to predict price changes
Gamblers are uniformed traders that guess
Describe a Sentiment-oriented technical trader
type of parasitic order-anticipator trader
Traders that predict trades that uninformed traders will decide to make
Describe a front runner
Type of parasitic order-anticipator trader
Know or infer future trades and demand liquidity before demand increases
buys before and sells after deamnd increases
Describe a quote matcher
Type of parasitic order-anticipator trader
Exploit option values of standing limit orders
Describe a value trader
type of informed trader
Estimate fundamental value using economic models
Describe a news trader
Type of informed trader
Estimate changes in fundamental value from news
Describe an information-oriented technical trader
Type of informed trader
Try to forecast prices from past prices and other market data
Describe informed traders and their trading strategy
Informed traders are rational decision-makers that trade on fundamental value of an asset
trade when market price deviates from fundamental value
Attempt to make profit with minimal price impact to hide intentions
If information is public = trade aggressively
Private info = trade slowly
How can you tell the difference between private and public information?
Can you act of each type?
- Considers timing
private = unscheduled - Significance of the information
Both can be traded on
*private cannot if you have a fiduciary duty
What is the effects of informed traders?
Increase market efficiency by moving prices towards fundamental value
Who do informed traders make money from?
Uninformed traders
Define an efficient market
A market where prices reflect all available information
What are the three forms of market efficiency
- Weak form
- Semi-strong
- Strong form
What factor do traditional market efficiency definitions fail to identify?
The cost of acquiring and acting on information
What is the market microstructure definition of efficiency?
A market where traders cannot profit from acquiring and acting on information
Mc=Mb
