Arms Sales in Financial Markets
48 Pages Posted: 30 Jun 2022 Last revised: 15 Mar 2024
Date Written: November 16, 2023
Abstract
Many financial transactions are of a fixed-sum nature, meaning that improvements in the terms of trade for one party come at the expense of another party. We model how the sales of trading advantages (e.g., data or co-location services) affect traders' endogenous participation in financial markets and vice-versa. Sellers of trading advantages (e.g., data providers or securities exchanges) maximize profits by charging prices that may lead to inefficiently low levels of market participation and liquidity in equilibrium. Optimal sales of trading advantages lead less sophisticated investors to conclude that financial markets are too "rigged'' and to exit these markets.
Keywords: Market participation, informational advantage, data sales, collocation, rigged markets, externalities
JEL Classification: G20, G14, D82, D42
Suggested Citation: Suggested Citation