Markets With Random Lifetimes and Private Values: Mean-Reversion and Option to Trade

Jakša Cvitanic, Charles Plott, Chien-Yao Tseng: We consider a market in which traders arrive at random times, with random private values for the single traded asset.

Author(s) :

Jaksa Cvitanic

Charles Plott

California Institute of Technology, Pasadena

Chien-Yao Tseng

California Institute of Technology, Pasadena

A trader’s optimal trading decision is formulated in terms of exercising the option to trade one unit of the asset at the optimal stopping time. We solve the optimal stopping problem under the assumption that the market price follows a mean-reverting diffusion process. The model is calibrated to experimental data taken from Alton and Plott (2010), resulting in a very good fit. In particular, the estimated long-term mean of the traded prices is close to the theoretical long-term mean at which the expected number of buys is equal to the expected number of sells. We call that value Long-Term Competitive Equilibrium, extending the concept of Flow Competitive Equilibrium (FCE) of Alton and Plott (2010).
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Markets With Random Lifetimes and Private Values: Mean-Reversion and Option to T...
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Type : Working paper
Date : le 05/12/2011
Extra information : For more information, please contact EDHEC Research and Development Department [ research@drd.edhec.edu ]
Research Cluster : Finance

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