Prices, Price Processes, Volume and Their Information - a Survey of the Market Microstructure Literature -

This paper provides an up-to-date review and summary of the existing literature on the informational aspects of price processes. A common feature of these models is that prices reflect information that is dispersed among many traders. The paper begins by contrasting the Rational Expectation Equilibrium concept with the Bayesian Nash Equilibrium concept, and then draws a connection between market completeness and information revelation. The No-Speculation Theorem and the No-Trade Theorems are also explained. The No-Trade Theorems describe circumstances where asymmetric information can lead to market breakdown even though there are gains from trade. The paper also examines situations under which bubbles can occur even when all traders are rational and forward looking. The second part of the survey addresses CARA-Gaussian market microstructure models. These models are classified into five groups. A distinction is drawn between limit order models and market order models. These models are further subdivided into models with strategic or competitive traders. Dynamic models are used to illustrate a rationale for technical/chart analysis. The various types of herding models are described in the final section