Informed Trading With Multiple Competitive Brokers

Abstract:     
We study competitive, but strategic, brokers executing trades for an informed trader in a single and multi-period setting. When brokers act as principals and agents in the same transaction, informed traders benefit and uninformed traders are hurt relative to a model with no brokers. This result is opposite to related models with a single broker. When brokers act as principals and agents in different transactions, they can choose to execute the order, as agents, first, and trade for themselves, as dealers afterwards; or, trade for themselves first and execute the order later. The informed trader always prefers to have his order executed first. Surprisingly, for greater than a critical number of brokers, brokers also prefer to execute the informed trader's order first. We empirically show that this critical number is exceeded for the futures contracts in our sample. An important implication of our result is that competition between brokers can mitigate trading abuses (such as front-running) arising from a conflict between brokers' agency and principal functions.

Number of Pages in PDF File: 50

JEL Classification: G12

working papers series