How to do the nature and the structure of information affect the optimal pricing algorithm to guarantee market efficiency and minimize fundamental prices volatility ?

Overview & Synopsis

This work assesses the capability of financial markets in general and then of standardized agricultural commodity markets to aggregate information in the market price and reduce the price volatility. This work presents two new models based on the nature of the information itself. We split the information that is treatable using an algorithm (effective) and the information that cannot. The impact of the predominantly used price determination algorithm, the limit order book, is examined with regard to the nature and structure of the information. These models underline that when the information is mostly effective and continuous, the limit order book indeed allows the market price to be close to its fundamental value. When non effective information becomes too important, this mechanism leads to a bubble or even a crisis. But even in a bubble, the market price can reveal more information than any agent taken separately. When information is discontinuous, on the other hand, as it is the case in commodity markets, the different pricing algorithms used in physical markets and futures markets can lead to a decrease in the market price efficiency but also to a surplus of price volatility. Finally, we take into account the number of agents as a determining variable of the frequency of transactions and of the incoming information on the commodity market on the first hand, and the possibility of having a non effective information on the other hand. The intuition that more agents increase the market price efficiency is not mandatory in this model. Moreover, it can generate more volatility. We also show that underestimating the impact of the non efficient information and overestimating it do not have identical consequences on the properties of the market price.