Risk Aversion, Market Liquidity, and Price Efficiency

Abstract

A model of a noncompetitive speculative market is analyzed in which privately informed traders and market makers are risk averse. Market liquidity is found to be nonmonotonic in the number of informed traders, their degree of risk aversion, and the precision of their information. It is also shown that increased liquidity trading leads to reduced priced efficiency, and that, under endogenous information acquisition, market liquidity may also be nonmonotonic in the variance of liquidity trades.