Generalized second law of thermodynamics in the Glosten-Milgrom model

Abstract

We derive an upper bound for the expected gain of informed traders in the Glosten-Milgrom model with finite horizon, fully analogous to a generalized second law of thermodynamics. This result extends that obtained by Touzo et al. a couple of years ago. The proof relies on Bayesian inference (exploiting the invariance of the problem under consecutive game sequences) and an interesting entropic inequality. We also provide numerical results both supporting the existence of a characteristic timescale in the model and illustrating the magnitude of gain fluctuations. Other possible extensions are discussed.