Monday, April 27, 2009

information-motivated and liquidity-motivated transactions

there are two major reasons for security transactions. An investors may believe that a security has become mispriced ,that its value is outside the current range between (1)the total proceeds from a sale and (2)the total cost of a purchase. One who feeds this way believes that he or she has information not known to (or understood by)the market in general and may be termed an information-motivated trader.On the other hand,an investor may simply want to sell securities to buy a new car,buy some securities with recently inherited money.alter a portfolio to better conform to a recent change in job,or the like. Such a person may be termed liquidity-motivated:although feeling that value is also outside the proceeds/cost range.he or she does not presume that others in the market have evaluated the prospects for the security incorrectly.
dealers can make money by trading with liquidity-motivated traders or with stupid information-motivated traders. But,on average,they can only lose money by trading with clever information-motivated traders.
The larger a dealer,s bid-ask spread,the less business he or she will do;but whatever the spread, when a clever information-motivated investor makes a trade,the dealer may expect to lose.

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