Leading academics, bankers and regulators gathered at the Robert H. Smith School of Business recently for a conference honoring the Smith School’s Albert “Pete” Kyle — specifically, the thirtieth anniversary of the publication of Kyle’s seminal 1985 paper “Continuous Auctions and Insider Trading.” The paper is considered a landmark in the literature related to market microstructure, the subfield of economics that explores the ways in which the processes of a market affect such things as transaction costs, prices and liquidity.
Co-sponsored by the Smith School’s Center for Financial Policy and UBS, the conference combined discussion of the paper’s influence, tributes to Kyle as a scholar and mentor and scholarly presentations on topics related to financial markets, regulation and corporate finance.
“Kyle ’85,” as it is known in shorthand, appeared in the journal Econometrica. "It is one of the first papers that revealed how private information is revealed by trading," said Robert Engle, a Nobel Prize winner in economics and the Michael Armellino Professor of Finance at New York University’s Stern School of Business, who delivered one of the conference's two keynote addresses.
In the paper, Kyle, the Charles E. Smith Chair Professor of Finance at the Smith School, examined a hypothetical interaction among three types of traders: a single actor with precise information about the value of a security, "noise" traders who beat the market only 50 percent of the time, and market makers who facilitate trades. The paper explores how the information possessed by the insider gets incorporated into the price of the asset at various trading volumes, over various intervals. The noise trades serve to mask the trades of the informed trader. (That is, the informed trader is able to conceal his private information by hiding his trades among those of the uninformed.)
Kyle, a Rhodes Scholar who did his PhD work at the University of Chicago, wrote the paper while on the faculty at Princeton. At the conference, he said its genesis could be traced to conversations he had had with his father, a cotton farmer and cotton broker in Memphis who later marketed cotton for a large farmers' cooperative in Lubbock, Tex. “People would say that the stock market was an example of a perfect market, but I would listen to my father say things that contradicted that,” Kyle said. “He would complain, ‘If I want to sell more, the market maker charges too much.’ He thought that some people were trading based on private information.”
As Kyle began his serious academic study of economics, he continued to be nagged by the "huge disconnect between how economists talked about the market and how markets worked,” he said.
Over the course of the two-day conference, scholars from across the country presented papers on topics like “Information Content of Hedge Fund Trading” and “The Ripple Effects of Noise on Corporate Investment.” Practitioners from UBS, Blackrock, Vanguard, and elsewhere discussed the effects on markets of high-frequency trading, the growth in the number of exchanges in the U.S. and Europe, and the growing popularity of exchange traded funds (ETFs). Russell Wermers, director of the Center for Financial Policy, observed in his introductory remarks that the conference aligned with CFP’s mission: "To get professionals, regulators and academics into the same room, in a non-threatening environment.”
Jeremy Stein, the Moise Y. Safra Professor of Economics at Harvard University, who served on the Board of Governors of the Federal Reserve System from 2012 to 2014, gave the conference's other keynote address. He discussed academic work providing empirical support for the idea that the Fed ought to pay attention to credit “bubbles" in deciding where to set rates. But he began by talking about how Kyle had guided him, when he was an undergraduate at Princeton, through a graduate-level economics course in which Stein felt he was floundering, then nudged him toward graduate school.
“I’m not exaggerating when I say that I would not be in this occupation if Pete had not showed me generosity and kindness at a time when it really mattered,” Stein said.
As a teacher, Stein said, Kyle was “the Platonic ideal for what we should be doing in this profession."