Financial Expertise as an Arms Race

50 Pages Posted: 30 Aug 2009 Last revised: 15 Mar 2013

See all articles by Vincent Glode

Vincent Glode

University of Pennsylvania - The Wharton School

Richard C. Green

Carnegie Mellon University - David A. Tepper School of Business

Richard Lowery

University of Texas-Austin

Date Written: July 6, 2011

Abstract

We show that firms intermediating trade have incentives to overinvest in financial expertise, and that these investments can be destabilizing. Financial expertise in our model improves firms' ability to accurately estimate value when trading a security. It creates adverse selection, which under normal circumstances works to the advantage of the expert. It deters opportunistic bargaining by counterparties. That advantage is neutralized in equilibrium, however, by offsetting investments competitors make. Moreover, when volatility rises the adverse selection created by expertise triggers breakdowns in liquidity, destroying gains to trade and thus the benefits that firms hope to gain through high levels of expertise.

JEL Classification: G20, D82, C78

Suggested Citation

Glode, Vincent and Green, Richard C. and Lowery, Richard, Financial Expertise as an Arms Race (July 6, 2011). Journal of Finance, 2012. Available at SSRN: https://ssrn.com/abstract=1463077

Vincent Glode (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Richard C. Green

Carnegie Mellon University - David A. Tepper School of Business ( email )

315B Schenley Park
Pittsburgh, PA 15213-3890
United States
412-268-2302 (Phone)
412-268-7064 (Fax)

Richard Lowery

University of Texas-Austin ( email )

Red McCombs School of Business
Austin, TX 78712
United States

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