Arrow-Debreu Meets Kyle

Abstract

We consider an extension of the Kyle (1985) model where Arrow-Debreu securities are traded and the informed trader has private information regarding arbitrary higher moments of the asset payoff distribution. In this setting, we analyze price discovery and informed demand of Arrow-Debreu securities---equivalently, options. The informed trader strategy in our model is consistent with options trading strategies used to trade on higher moments in practice. The probability law of market maker's posterior is independent of specification of asset payoffs. The information efficiency of Arrow-Debreu prices decreases with respect to the dispersion of the informed trader's private signal.