Adverse Selection and Intermediation Chains
University of Pennsylvania - Finance Department; University of Pennsylvania - The Wharton School
Christian C. Opp
The Wharton School, University of Pennsylvania; University of Pennsylvania - Finance Department
April 29, 2013
We propose a parsimonious model of over-the-counter trading under asymmetric information to study the presence of intermediation chains that stand between heterogeneously informed market participants. We show that moderately informed intermediaries can reduce trading inefficiencies due to asymmetric information by layering an adverse selection problem over multiple transactions. Informed market participants may prefer to trade through one or more of these intermediaries as they improve trade efficiency but also reduce the surplus accruing to uninformed traders. Our model makes novel predictions about optimal network formation when adverse selection problems impede the efficiency of trade.
Number of Pages in PDF File: 31
Keywords: Intermediation Chains, OTC Trading Networks, Adverse Selection, Asymmetric Information
JEL Classification: G20, D82, D85working papers series
Date posted: March 14, 2013 ; Last revised: April 29, 2013
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