On Competitive Nonlinear Pricing

Abstract

Many financial markets rely on a discriminatory limit-order book to balance supply and demand. We study these markets in a static model in which uninformed market makers compete in nonlinear tariffs to trade with an informed insider, as in Glosten (1994), Biais, Martimort, and Rochet (2000), and Back and Baruch (2013). We analyze the case where tariffs are unconstrained and the case where tariffs are restricted to be convex. In both cases, we show that pure-strategy equilibrium tariffs must be linear and, moreover, that such equilibria only exist under exceptional circumstances. These results cast doubt on the stability of even well-organized financial markets.

Keywords: adverse selection, competing mechanisms, limit-order book

JEL Classification: D43, D82, D86