Information chasing versus adverse selection

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 08 April 2022

Staff Working Paper No. 971

By Gábor Pintér, Chaojun Wang and Junyuan Zou

Contrary to the prediction of the classic adverse selection theory, a more informed trader could receive better pricing relative to a less informed trader in over‑the‑counter financial markets. Dealers chase informed orders to better position their future quotes and avoid winner’s curse in subsequent trades. When dealers are perfectly competitive and risk averse, their incentive of information chasing dominates their fear of adverse selection. In a more general setting, information chasing can dominate adverse selection when dealers face differentially informed speculators, while adverse selection dominates when dealers face differentially informed trades from a given speculator. These two seemingly contrasting predictions are supported by empirical evidence from the UK government bond market.

Information chasing versus adverse selection

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