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Adverse Selection and Intermediation ChainsVincent GlodeUniversity of Pennsylvania - Finance Department; University of Pennsylvania - The Wharton School Christian C. OppThe Wharton School, University of Pennsylvania; University of Pennsylvania - Finance Department April 29, 2013 Abstract: 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, D85 working papers seriesDate posted: March 14, 2013 ; Last revised: April 29, 2013Suggested CitationContact Information
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