Equilibrium Price Formation with a Major Trading Firm and Many Small Firms

Summary

The article studies how an equilibrium security price can emerge when one large financial firm trades alongside many smaller firms. Each participant trades continuously through an exchange to reduce its own costs, while facing both firm specific and shared sources of uncertainty, as well as stochastic client order flows.

The analysis derives the price process that balances aggregate demand and supply, including the way the major firm's trading affects prices. It does this first for a market with a finite number of participants and then for a mean field limit representing a large population of minor firms. This offers a theoretical framework for studying price formation and asymmetric market impact. The supplied description does not provide the model equations, assumptions in detail, empirical evidence, or quantitative estimates, so practical implications for a particular market or execution strategy cannot be assessed from the excerpt alone.

Key ideas

• The model includes one major firm and a large population of smaller trading firms.
• Firms trade continuously to minimize costs while facing idiosyncratic and common noise.
• Stochastic order flows from clients are part of the price formation setting.
• The equilibrium price balances securities demand and supply and is derived endogenously.
• The analysis covers both finite populations and a mean field limit, but the excerpt gives no empirical validation.

Tags

# Equilibrium Price Formation with a Major Player and its Mean Field Limit


# Equilibrium Price Formation with a Major Player and its Mean Field Limit









In this article, we consider the problem of equilibrium price formation in an incomplete securities market consisting of one major financial firm and a large number of minor firms. They carry out continuous trading via the securities exchange to minimize their cost while facing idiosyncratic and common noises as well as stochastic order flows from their individual clients. The equilibrium price process that balances demand and supply of the securities, including the functional form of the price impact for the major firm, is derived endogenously both in the market of finite population size and in the corresponding mean field limit.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.