Rational destabilization in a frictionless market

This paper studies the effect of informed trading on prices in a dynamic model with two-dimensional private information. We show that a trader with private information about the asset's value and a persistent liquidity shock trades along with and exacerbates the shock. The price changes more than if the shock was unexpected. When shocks are small, the with-wind trade is so strong that the distribution of prices and asset holdings changes discontinuously from the stabilizing linear equilibrium without them. The results demonstrate strategic price destabilization in a market with no capital or trade frictions. (C) 2020 Elsevier Inc. All rights reserved.