Kyle meets time-inconsistency: a dynamic mean--variance informed trading problem

Abstract

We study a Kyle--Back model in which the informed trader has dynamic mean--variance preferences, leading to a time-inconsistent trading problem that is formulated as an intrapersonal game. The model combines two equilibrium requirements: a trading--pricing equilibrium between the informed trader and the market maker, and a time-consistent equilibrium among the trader's successive selves. Following the framework of Cho (2003), we consider both risk-neutral and risk-averse informed traders. In the risk-neutral case, we derive the equilibrium trading strategy and price impact explicitly. In the risk-averse case, we establish existence and characterize the equilibrium through a coupled system of nonlinear ordinary differential equations. Our main technique is to reduce the equilibrium conditions to a forward--backward ODE system and resolve the resulting boundary conditions by a shooting argument. Economically, the mean--variance preference reshapes the intertemporal trade-off between exploiting current private information and preserving future informational advantage, generating a declining term structure of price impact and shifting both information revelation and informed-trading profits toward earlier stages of the trading horizon.