On the Endogeneity of Trading Arrangements

Abstract:     
It is common in the literature to treat trading arrangements as exogenous. Yet, the sheer variety of existing arrangements shows that they are in fact subject to choice. This paper presents a formal analysis of endogenous trading arrangements. I show that observed trading arrangements differ by their ability to facilitate trading. I argue that this property must be taken into account when a choice of a trading mechanism is made. I show that as a result, the choice of a trading arrangement depends on the responses of economic agents to specific market conditions.

I present the general argument in the context of emerging foreign exchange markets which exhibit a particularly wide cross-sectional variety of actual trading arrangements. Trading arrangements in emerging foreign exchange markets are of three types: auctions, dealer markets, and mixed, auction-dealer combinations. By formally modeling the institutional details of these markets and applying the premise that trading arrangements are endogenous, I show that a trading arrangement can be chosen by rational agents as a best response to alternative market conditions.

Note: This is a description of the article and not the actual abstract.

JEL Classification: G19, F31

Accepted Paper Series