Decision Rules and Their Influence on Asset Prices

This paper develops a market microstructure model with asymmetric information in order to quantify the influence which practical decision rules have on asset prices. The users of practical decision rules have incomplete information at their disposal and trade in a market with both fully informed and uninformed investors, as well as with a competitive market maker. The users of practical decision rules affect the periodical ask and bid prices in two ways: by means of the precision of their information and through their share in the totality of investors, respectively. The resulting bid-ask spread is positive and proportional to the c.p. variation of these two influencing factors and is attributable to adverse selection costs