A Model of Middlemen and Oligopolistic Market Makers

Abstract:     
This paper studies the endogenous structure of intermediation when heterogeneous intermediaries choose between becoming a middleman or a market maker, and the relation between the equilibrium market structure and price dispersion. We obtain three main results: First, middlemen and oligopolistic market makers can coexist in the market equilibrium. All market makers publicly post unique ask and bid prices. These prices serve as the high and low bounds respectively for the ask and bid prices of middlemen, when capacity cost is sufficiently large. Second, more efficient intermediaries choose to become market makers, while less efficient intermediaries choose to become middlemen. Third, if the fixed cost of capacity installation for market makers increases, the number of market makers declines, while the number of middlemen increases. As a result, both ask prices and bid prices become more dispersed.

Number of Pages in PDF File: 30

Keywords: oligopolistic market makers; middlemen; intermediaries; price dispersion

JEL Classification: D43, L11, L13

working papers series