Design of Synthetic Financial Products in Decentralized Markets

63 Pages Posted: 14 Jul 2020 Last revised: 3 Jan 2022

See all articles by Marzena J. Rostek

Marzena J. Rostek

University of Wisconsin - Madison

Ji Hee Yoon

University College London - Department of Economics

Date Written: December 31, 2021

Abstract

Decentralized trading motivates financial innovation that would be neutral if assets cleared jointly: Derivatives are generally nonredundant. In markets with large traders, derivatives alter price impact for the underlying assets and, when suitably designed, improve risk sharing and diversification. While mutual funds are efficient in competitive markets, imperfect competition qualifies their efficiency with decentralized trading. Instead, a limited number of synthetic products tailored to traders' desired risk profile strictly increase welfare under general conditions. The efficient set of securities allows trading all fundamental risks but generally forgoes hedging all contingencies in response to price impact.

Keywords: Imperfect competition, Market design, Decentralized market, Security design, Innovation, Liquidity, Price impact, Uniform-price auction, Efficiency

JEL Classification: D47, D53, G11, G12

Suggested Citation

Rostek, Marzena J. and Yoon, Ji Hee, Design of Synthetic Financial Products in Decentralized Markets (December 31, 2021). 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 - Department of Economics ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

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