Risk aversion, informative noise trading, and long-lived information

We build a dynamic strategic trading model in which noise trading demand may be correlated with an asset's fundamental value. This correlation shapes the temporal properties of a perfect Bayesian equilibrium. The more positive the correlation coefficient, the faster prices incorporate private information. In contrast, when the cor-relation is negative and only one risk-neutral insider exists, an abundant amount of private information cannot be revealed after the final trade, and market liquidity deteriorates over time. Moreover, information is revealed faster during earlier periods if positively correlated noise demand is concentrated early, whereas more infor-mation remains hidden after the final trade if negatively correlated noise demand is concentrated later. The inefficiency caused by negatively correlated noise demand can be resolved if insiders are competitive or risk averse.

Automated summary

A dynamic strategic trading model was built to study the correlation between noise trading demand and asset fundamental value, which impacts the temporal properties of a perfect Bayesian equilibrium. The correlation coefficient influences how quickly prices incorporate private information. Market liquidity deteriorates if a large amount of private information cannot be revealed due to a negative correlation and the presence of only one risk-neutral insider. Efficiency issues caused by negatively correlated noise demand can be resolved by competitive insiders or risk-averse ones.