Asymmetric Information and Intermediation Chains

Abstract

We propose a parsimonious model of bilateral trade under asymmetric information to shed light on the prevalence of intermediation chains that stand between buyers and sellers in many decentralized markets. Our model features a classic problem in economics where an agent uses his market power to inefficiently screen a privately informed counterparty. Paradoxically, involving moderately informed intermediaries also endowed with market power can improve trade efficiency. Long intermediation chains in which each trader's information set is similar to those of his direct counterparties limit traders' incentives to post prices that reduce trade volume and jeopardize gains to trade.

Keywords: Intermediation Chains, Asymmetric Information, OTC Trading Networks, Monopoly Power, Double Marginalization

JEL Classification: G23, D82, D85, L10