Price Discovery as a Public Good: Why Dealers Do Not Engage in Bertrand Price Competition

30 Pages Posted: 5 Dec 2001

See all articles by Christopher G. Lamoureux

Christopher G. Lamoureux

University of Arizona

Charles R. Schnitzlein

School of Business, University of Vermont

Date Written: May 2001

Abstract

Empirical studies of asset markets and a growing experimental literature suggest that in many cases competing dealers earn some monopoly rents: they do not arrive at a Bertrand equilibrium. In spite of this, little attention has been paid to the competitive forces that impinge on dealers' abilities to earn monopoly rents. Consider a transparent, consolidated market with competing dealers. Any dealer's incentive to invest in learning about the asset's true value is mitigated by the fact that her competitors will have equal access to the information in the order flow. This suggests that in a transparent multiple dealer market we might see wider spreads and larger dealer profits than in a setting where dealers are able to internalize the benefits of price discovery. In this paper we use the economic laboratory to compare these two settings: 1) three competing dealers in a single asset with 2) three assets with a monopoly dealer in each. We find that: bid-ask spreads are wider, prices are less responsive to order flow (so there is less price discovery), and dealer profits are larger in the single asset setting. These findings suggest that when dealers are able to internalize the gains from price discovery, they compete more aggressively than when they do not have a monopoly franchise in a single asset. A dealer has little incentive to set a tight spread to pin down the asset value when her competitors will also observe the order flow.

Suggested Citation

Lamoureux, Christopher G. and Schnitzlein, Charles R., Price Discovery as a Public Good: Why Dealers Do Not Engage in Bertrand Price Competition (May 2001). AFA 2002 Atlanta Meetings. Available at SSRN: https://ssrn.com/abstract=293038 or http://dx.doi.org/10.2139/ssrn.293038

Christopher G. Lamoureux (Contact Author)

University of Arizona ( email )

Tucson, AZ 85721
United States
520-621-7488 (Phone)
520-621-1261 (Fax)

Charles R. Schnitzlein

School of Business, University of Vermont ( email )

Burlington, VT 05405
United States
802-656-9281 (Phone)

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