Upending Stock Market Structure
Using MPC
CHARANJIT S. JUTLA
IBM RESEARCH
Talk Outline
•What exactly is the purpose of the stock market?
•Is there a problem with the stock market?
•Demand and Supply (Eco-101)
•Modeling (Private) Information in Equilibrium Pricing
•Price Discovery Mechanisms
•Novel (or antiquated) Structure of Stock Market
•Illustrative Analysis
Stock Market Purpose
Price Discovery
◦ Important for investment decisions
◦ Effectively centralizes distributed information
Liquidity – it is a market!
NYSE vs NASDAQ (Double Auctions)
Is there a problem?
◦ What’s with all the day traders and HFT? Liquidity?
◦ Trusting the Specialist to hide your bids?
◦ Let’s Model
Walrasian Equilibrium (1877)
Walrasian Equilibrium
Grossman-Stiglitz Critique (1980)
Impossibility of Informationally efficient markets
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Efficient Markets Hypothesis – Prices reflect all the information
Even “Informed” Traders “Private” Information?
Then informed traders have no incentive.
So, in “equilibrium” no one is doing any research!
But, that is not an equilibrium!
CONCLUSION: Prices do not reflect all the information.
Easley-O’Hara Model (2004)
Cumulative Demand
and Supply
BUY
SELL
CLEARING PRICE
DOUBLE AUCTION
(CPDA)
Market price sell
Market price buy
price
Cumulative Demand
and Supply
price
Cumulative Demand
and Supply
s
price
Upshot
If there is no private signal, or “signal” is public knowledge:
◦ converges to Walrasian equilibrium.
◦ incentivizes “uninformed”.
Private Information is clearly not revealed till auction is over.
◦ Informed are further incentivized.
◦ Uninformed continue to get a return (so liquidity providers remain).
◦ If everyone does research, faster equilibrium pricing!
Open Questions?
◦ Mostly Finance Questions.
◦ But, Additional Leakage - Performance Tradeoffs.
◦ Treating Buyers and Sellers symmetrically in analysis.
◦ Volume reveals signal after auction is over in simple model.
◦ Periodic CPDA.
THANKS!