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Consider the sequential trading model of Glosten and Milgrom (1985). Let us assume that: The future value of the asset, V, can take the value
Consider the sequential trading model of Glosten and Milgrom (1985). Let us assume that: The future value of the asset, V, can take the value of 4 or 5 with equal probability. That is, 0 = 0.5. Half the traders are informed and half are uninformed. That is a = 0.5. Further, assume that the uninformed traders are equally likely to buy or sell. The dealer earns zero expected profits, such that: at = E( VB) bz = E(VIS) where a is the ask price, b is the bid price, B; indicates a buy order and S, indicates a sell order all at time t. Given Bayes' theorem: P(Y) P(Y|Z) = P(Z|Y) P(Z) solve for the bid price, ask price and bid-ask spread at time t. (10 marks) [Type your response here] (b) Now, assuming a sale at time t, solve for the bid price, ask price and bid-ask spread at time t + 1. (5 marks) [Type your response here] Consider the sequential trading model of Glosten and Milgrom (1985). Let us assume that: The future value of the asset, V, can take the value of 4 or 5 with equal probability. That is, 0 = 0.5. Half the traders are informed and half are uninformed. That is a = 0.5. Further, assume that the uninformed traders are equally likely to buy or sell. The dealer earns zero expected profits, such that: at = E( VB) bz = E(VIS) where a is the ask price, b is the bid price, B; indicates a buy order and S, indicates a sell order all at time t. Given Bayes' theorem: P(Y) P(Y|Z) = P(Z|Y) P(Z) solve for the bid price, ask price and bid-ask spread at time t. (10 marks) [Type your response here] (b) Now, assuming a sale at time t, solve for the bid price, ask price and bid-ask spread at time t + 1. (5 marks) [Type your response here]
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