Cream Skimming in Financial Markets
Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
Columbia Business School; National Bureau of Economic Research (NBER)
Jose A. Scheinkman
Columbia University; Princeton University - Department of Economics; National Bureau of Economic Research (NBER)
NBER Working Paper No. w16804
We propose an equilibrium occupational choice model, where agents can choose to work in the real sector (become entrepreneurs) or to become informed dealers in financial markets. Agents incur costs to become informed dealers and develop skills for valuing assets up for trade. The financial sector comprises a transparent competitive exchange, where uninformed agents trade and an opaque over-the-counter (OTC) market, where informed dealers offer attractive terms for the most valuable assets entrepreneurs put up for sale. Thanks to their information advantage and valuation skills, dealers are able to provide incentives to entrepreneurs to originate good assets. However, the opaqueness of the OTC market allows dealers to extract informational rents from entrepreneurs. Trade in the OTC market imposes a negative externality on the organized exchange, where only the less valuable assets end up for trade. We show that in equilibrium the dealers' informational rents in the OTC market are too large and attract too much talent to the financial industry.
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Number of Pages in PDF File: 52working papers series
Date posted: February 28, 2011
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