Legal Protection in Retail Financial Markets
Bruce I. Carlin
University of California, Los Angeles (UCLA) - Anderson School of Management
Duke University - Fuqua School of Business
November 2, 2008
AFA 2010 Atlanta Meetings Paper
Given the importance of sound advice in retail financial markets and the fact that financial institutions outsource their advice services, how should consumer protection law be set to maximize social welfare? We address this question by posing a theoretical model of retail markets in which a firm and a broker face a bilateral hidden action problem when they service clients in the market. All participants in the market are rational, and prices are set based on consistent beliefs about equilibrium actions of the firm and the broker. We characterize the optimal law, and derive how the legal system splits the blame between parties to the transaction. We also analyze how complexity in assessing clients and conflicts of interest affect the law. Since these markets are large, the implications of the analysis have great welfare import.
Number of Pages in PDF File: 36
Keywords: retail financial market, brokerage, regulation, law, contract, welfare
JEL Classification: G20, G38, D20, D62, K20, K12, L84
Date posted: March 13, 2009
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