A Dynamic Market Microstructure Model with Insider Information and Order Book

This paper studies a dynamic market microstructure model in which a strategic market maker competes with an informed trader. We include the presence of noise traders and limit order traders in our setup. Our model is a N-period model. We give necessary and sufficient conditions for an equilibrium to exist and provide conditions for it to be unique. Moreover, both the informed trader and the market maker try to maximize their profits. The resulting recursive equations lead to various economic interpretations. We investigate the interplay of different information sets. Each agent learns about the information of the other agent through their respective actions in the financial market. Finally we compare this competitive situation for the market maker as in Kyle (1985).