How Does Learning Affect Market Liquidity? A Simulation Analysis of a Double-Auction Financial Market with Portfolio Traders.

We study the relationship between liquidity and prices in an artificial financial market whereportfolio traders with limited resources interact through a continuous, electronic open book.We depart from the standard asset pricing framework in two ways. First, we assume thatinvestors have incomplete information about the distribution of returns. Second, we model theportfolio choice problem using prospect-type preferences. We model the utility function interms of deviations of the portfolio growth rate from a specified target growth rate, and weassume that investors are more sensitive to downside movements. We show that theparameters defining the learning process affect the price dynamics through their impact on thevariability of the market liquidity.