Financial Product Design in Decentralized Markets

44 Pages Posted: 14 Jul 2020 Last revised: 13 Feb 2024

See all articles by Marzena J. Rostek

Marzena J. Rostek

University of Wisconsin-Madison

Ji Hee Yoon

University College London

Date Written: February 11, 2024

Abstract

Decentralized trading motivates financial innovation, making synthetic products like derivatives nonredundant, even when all traders trade all assets. This nonredundancy arises because derivatives affect cross-security inference (information) and, in markets with large traders, equilibrium price impact (liquidity). The efficient securities differ from the underlying assets. While the market index/mutual funds are efficient in decentralized markets with competitive investors, heterogeneous portfolios that balance index tracking with liquidity transformation become efficient in markets with large traders. Efficient securities facilitate the trading of all fundamental risks but generally forgo hedging all contingencies to minimize the price impact costs associated with risk sharing and diversification.

Keywords: Imperfect competition, Decentralized market, Security design, Market design, Liquidity, Price impact, Efficiency

JEL Classification: D47, D53, D82, G11, G12

Suggested Citation

Rostek, Marzena J. and Yoon, Ji Hee, Financial Product Design in Decentralized Markets (February 11, 2024). Available at SSRN: https://ssrn.com/abstract=3631479 or http://dx.doi.org/10.2139/ssrn.3631479

Marzena J. Rostek

University of Wisconsin-Madison ( email )

1180 Observatory Drive
Madison, WI 53703
United States
(608) 262-6723 (Phone)
(608) 262-2033 (Fax)

HOME PAGE: http://www.ssc.wisc.edu/~mrostek

Ji Hee Yoon (Contact Author)

University College London ( email )

Gower Street
London, WC1E 6BT
United Kingdom

HOME PAGE: http://https://sites.google.com/site/jiyoonmath/home

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