An Information-Based Theory of Financial Intermediation

73 Pages Posted: 22 Oct 2019

See all articles by Zachary Bethune

Zachary Bethune

University of Virginia

Bruno Sultanum

Federal Reserve Banks - Federal Reserve Bank of Richmond

Nicholas Trachter

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: 2019-07-02

Abstract

We advance a theory of how private information and heterogeneous screening ability across market participants shapes trade in decentralized asset markets. We solve for the equilibrium market structure and show that the investors who intermediate trade the most and interact with the largest set of counterparties must have the highest screening ability. That is, the primary intermediaries are those with superior information–screening experts. We provide empirical support for the model's predictions using transaction-level micro data and information disclosure requirements. Finally, we study the connection between screening ability and efficiency, and observe that a market where all investors are screening experts–and thus, a market with no private information–may be dominated in terms of welfare by a market with no screening experts.

Keywords: Over-the-counter markets, intermediation, private information

JEL Classification: D53, D82, G14

Suggested Citation

Bethune, Zachary and Sultanum, Bruno and Trachter, Nicholas, An Information-Based Theory of Financial Intermediation (2019-07-02). FRB Richmond Working Paper No. 19-12. Available at SSRN: https://ssrn.com/abstract=3473118

Zachary Bethune (Contact Author)

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

Bruno Sultanum

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Nicholas Trachter

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

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