On the Endogeneity of Trading Arrangements
Journal of Financial Markets
Posted: 11 Jul 2000
It is common in the literature to treat trading arrangements as exogenous. Yet, the sheer variety of existing arrangements shows that they are in fact subject to choice. This paper presents a formal analysis of endogenous trading arrangements. I show that observed trading arrangements differ by their ability to facilitate trading. I argue that this property must be taken into account when a choice of a trading mechanism is made. I show that as a result, the choice of a trading arrangement depends on the responses of economic agents to specific market conditions.
I present the general argument in the context of emerging foreign exchange markets which exhibit a particularly wide cross-sectional variety of actual trading arrangements. Trading arrangements in emerging foreign exchange markets are of three types: auctions, dealer markets, and mixed, auction-dealer combinations. By formally modeling the institutional details of these markets and applying the premise that trading arrangements are endogenous, I show that a trading arrangement can be chosen by rational agents as a best response to alternative market conditions.
Note: This is a description of the article and not the actual abstract.
JEL Classification: G19, F31
Suggested Citation: Suggested Citation