Front-running dynamics

Bernhardt, D. and Taub, B. (2008) Front-running dynamics. Journal of Economic Theory, 138(1), pp. 288-296. (doi:10.1016/j.jet.2007.05.005)

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Abstract

We integrate a monopolist dual trader into a dynamic model of speculation. In static settings, [J.-C. Rochet, J.-L. Vila, Insider trading without normality, Rev. Econ. Stud. 61 (1994), 131–152] establish an irrelevance result—expected equilibrium outcomes are the same whether the monopolist speculator sees liquidity trade or not; and Roell [Dual-capacity trading and market quality, J. Finan. Intermediation (1990), 105–124] shows that with multiple speculators, dual trading benefits liquidity traders. In dynamic settings, these results are reversed: a front-running speculator exploits knowledge of future liquidity trade, extracting greater profits by smoothing profit extraction intertemporally. Front running introduces positive serial correlation to order flow. Accordingly, market makers discount past order flow in prices, but prices retain the martingale property.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Taub, Professor Bart
Authors: Bernhardt, D., and Taub, B.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Journal of Economic Theory
Publisher:Elsevier
ISSN:0022-0531

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