Efficient Cyber Risk: Security and Competition in Financial Markets

59 Pages Posted: 12 Mar 2020 Last revised: 16 Jun 2020

See all articles by Michael Brolley

Michael Brolley

Wilfrid Laurier University

David Cimon

Wilfrid Laurier University - School of Business & Economics

Ryan Riordan

Queen's University - Smith School of Business

Date Written: February 12, 2020

Abstract

In financial markets, clients entrust their capital and data to financial infrastructure providers who are vulnerable to breaches. We develop a model in which infrastructure providers compete to provide secure and efficient client services, in the presence of a cyber-attacker. In equilibrium, provider competition leads to both lower fees and security investment, but potentially greater vulnerability, in comparison to a monopolistic platform. We find that providers prefer to consolidate into a single platform, whereas clients prefer a fragmented infrastructure. The inefficiency of consolidated providers stems from under-investment in security when the market is small, and over-investment when the market is large. Policy makers should be wary of consolidation of critical financial infrastructure, as the impacts to security do not compensate clients for the increase in fees. Instead, minimum security investment requirements may improve security in competitive environments while yielding higher utility than the comparable monopoly platform.

Keywords: cyber risk, regulation, principal-agent, market structure, competition

JEL Classification: C7, C72, D4, G18, G2, G20, G21, G23

Suggested Citation

Brolley, Michael and Cimon, David and Riordan, Ryan, Efficient Cyber Risk: Security and Competition in Financial Markets (February 12, 2020). Available at SSRN: https://ssrn.com/abstract=3536974 or http://dx.doi.org/10.2139/ssrn.3536974

Michael Brolley

Wilfrid Laurier University ( email )

Lazaridis Hall, 4071
75 University Avenue
Waterloo, Ontario N2L 3C5
Canada

HOME PAGE: http://www.mikerostructure.com

David Cimon (Contact Author)

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
Canada

Ryan Riordan

Queen's University - Smith School of Business ( email )

Smith School of Business, Queen's University
143 Union Street
Kingston, Ontario K7L 3N6
Canada

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