Yenan Wang, Ming Yang - December 10, 2016
We study a continuous-time Kyle-Back model of insider trading with uncertainty about the existence of the insider. The market maker absorbs net market order flows and form beliefs about the asset’s true value as well as the presence of the insider. When the insider may not exist, the results depend on the setting of market power. The monopolistic market maker, in equilibrium, never updates his belief regarding the existence of the insider and hence his belief only converges to the truth conditional on the existence of the insider. This equilibrium does not exist with competitive market makers. Moreover, under additional conditions, there is no equilibrium with competitive market makers. When the insider exists for sure, both settings of market power generate essentially the same results that are consistent with the literature.