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Marriott Philadelphia Downtown, Meeting Room 406
Friday, Jan. 5, 2018 8:00 AM - 10:00 AM
The Emergence of Market Structure
AbstractWhat market structure emerges when market participants can choose the rate at which they contact others? We show that traders who choose a higher contact rate emerge as intermediaries, earning profits by taking asset positions that are misaligned with their preferences. Some of them, middlemen, are in constant contact with other traders and so pass on their position immediately. As search costs vanish, traders still make dispersed investments and trade occurs in intermediation chains, so the economy does not converge to a centralized market. When search costs are a differentiable function of the contact rate, the endogenous distribution of contact rates has no mass points. When the function is weakly convex, faster traders are misaligned more frequently than slower traders. When the function is linear, the contact rate distribution has a Pareto tail with parameter 2 and middlemen emerge endogenously. These features arise not only in the (inefficient) equilibrium allocation, but also in the optimal allocation. Moreover, we show that intermediation is key to the emergence of the rest of the properties of this market structure.
Trading Financial Innovation
AbstractStandardized financial securities are frequently traded in over-the-counter markets. This is difficult to reconcile with the view that these markets exist to facilitate the trade of customized contracts. We build a model of financial innovation to explain why standardized securities can be traded in decentralized markets. In our set-up, each dealer designs a security which specifies a payoff for every state of the world. The dealer chooses the states in which the payoff is flat and the states in which the payoff is contingent on the realized state of the world. Investors choose which securities to trade, taking into account how their trades may impact the price of each security. The market structure in which a given security is traded is determined endogenously. We characterize which securities are traded in decentralized rather than centralized markets. Our results also have implications for regulations that force all trade to take place in centralized markets.
Platform Trading with an OTC Market Fringe
AbstractWe study the privately and socially optimal participation of investors in a centralized platform or in an over-the-counter (OTC) market. Investors incur costs to trade in the platform, in the OTC market, or in both at the same time. Investors differ from each other in risk-sharing needs and OTC market trading capacities. We show that investors with low risk-sharing needs and large trading capacities endogenously emerge as OTC intermediaries, and have the strongest private incentives to enter the OTC market vs. the trading platform. Investors with strong risk-sharing needs and low trading capacities endogenously emerge as OTC customers, and have the weakest private incentive to enter the OTC market vs. the trading platform. Turning to social welfare, we provide two necessary conditions for customers' private incentives to be excessively large relative to their social contribution. Mandating or subsidizing trade in a centralized venue can be welfare improving only if these conditions are satised. First, investors must differ mostly in terms of OTC trading capacities. Second, participation costs must induce exclusive participation decisions. Based on the empirical trading patterns generated by closed-form examples of our model, we argue that the real-world OTC markets might satisfy the conditions under which mandating or subsidizing centralized trade is welfare improving.
- A1 - General Economics