Competition Among Exchanges and Enforcement Policy

32 Pages Posted: 22 Feb 2013

See all articles by Andrea Pescatori

Andrea Pescatori

Federal Reserve Bank of Cleveland

Cecilia Caglio

Board of Governors of the Federal Reserve System

Date Written: February 2013

Abstract

In this paper, we explore how competition among stock exchanges, operated as self-regulatory organizations (SROs), affects the design of their members' surveillance. We develop a model where two for-profit SROs compete for trading volume, while brokers execute transactions on behalf of the investors and may misreport the true cash flow. The SROs can deter a fraud by announcing an investigation and imposing a monetary penalty.The success of the investigation depends upon both the amount of resources devoted to monitoring and the efficiency of monitoring technologies. We show that when contracts are incomplete and investors do not have perfect information about the monitoring efficiency, competition among exchanges induces a race to the bottom in enforcement policy and a reduction in total welfare, compared to the case of a monopolist SRO.

Keywords: Enforcement Policy, Financial Regulation, Securities Industry, Self-Regulatory Organizations, Stock Exchanges, market surveillance

JEL Classification: G12, G14, G18, K22

Suggested Citation

Pescatori, Andrea and Caglio, Cecilia, Competition Among Exchanges and Enforcement Policy (February 2013). IMF Working Paper No. 13/37, Available at SSRN: https://ssrn.com/abstract=2222501

Andrea Pescatori

Federal Reserve Bank of Cleveland ( email )

1455 E 6th ST
Cleveland, OH 44114
United States

HOME PAGE: http://clevelandfed.org/Research/Economists/index.cfm?action=ShowAuthorPubs&author=676&pagetype=6

Cecilia Caglio

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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