The Winners and Losers of the Zero-Sum Game: The Origins of Trading Profits, Price Efficiency and Market Liquidity

Lawrence Harris, USC Working Paper, May 1993.

Abstract

Trading is a zero-sum game when measured relative to underlying fundamental values. No trader can profit without another trader losing. People trade because they obtain external benefits from trading. These benefits include expected returns from holding securities, risk reduction from holding correlated assets and gambling entertainment.

Three groups of stylized characteristic traders are examined. Winning traders trade for profit. Utilitarian traders trade because their external benefits of trading are greater than their losses. Futile traders expect to profit but for a variety of reasons their expectation are not realized.

Winning traders make prices efficient and provide most liquidity. Utilitarian and futile traders effectively underwrite the winning traders' efforts.

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Last revised 8/20/97.