Su Li
University of Maryland - Robert H. Smith School of Business

January 24, 2012

Abstract

I analyze the nature of imperfect competition among informed traders who continuously generate and exploit private information. I find the following results: (i) the combined trading of multiple informed traders is more aggressive than the monopolistic trader in Chau and Vayanos (2008), (ii) the equilibrium price is even more revealing of the informed trader's private information, and (iii) market depth improves as the number of informed traders increases; in the continuous trading limit, (iv) market is strong form efficient while aggregate profits of the informed traders remain bounded away from zero in sharp contrast to the corresponding results in Holden and Subrahmanyam (1992) and Foster and Viswanathan (1993), and (vi) informed traders contribute significantly to the trading volume and price volatility. The results can shed light on the empirical findings regarding high frequency traders, and help to explain why they remain to be profitable despite aggressive competition with each other, why their trading volume is very high, to what extent do they improve efficiency, and through what mechanism do they improve liquidity.