Andreas Uthemann, Systemic Risk Centre at the London School of Economics

“Higher-Order Uncertainty in Financial Markets: Evidence from a Consensus Pricing Service”

We assess the ability of an information aggregation mechanism to reduce valuation uncertainty in an over-the-counter market. The analysis is based on a unique dataset of price estimates for S&P 500 index options that major financial institutions provide to a consensus pricing service.

We consider two dimensions of uncertainty: uncertainty about fundamental asset values and strategic uncertainty about competitors' valuations. We estimate a structural model of learning from prices. From this, we obtain empirical measures of fundamental and strategic uncertainty that are based on market participants' posterior beliefs. Both dimensions of valuation uncertainty vary substantially across the different segments of the market. We use the structural model to assess subscribers' welfare under alternative information structures.

We show that the main contribution of the service is to reduce subscribers' uncertainty about competitors' valuations rather than uncertainty about asset values themselves.

Contact person: Peter Norman Sørensen