Adverse Selection and Intermediation Chains

44 Pages Posted: 6 May 2014 Last revised: 28 Aug 2022

See all articles by Vincent Glode

Vincent Glode

University of Pennsylvania - The Wharton School

Christian C. Opp

University of Rochester - Simon Business School; National Bureau of Economic Research (NBER)

Date Written: May 16, 2014

Abstract

We propose a parsimonious model of over-the-counter trading with asymmetric information to rationalize the existence of intermediation chains that stand between buyers and sellers of assets. Trading an asset through several heterogeneously informed intermediaries can preserve the efficiency of trade by reallocating an information asymmetry over many sequential transactions. Such an intermediation chain ensures that the adverse selection problems counterparties face in each transaction are small enough to allow for socially efficient trading strategies by all parties involved. Our model makes novel predictions about network formation and rent extraction when adverse selection problems impede the efficiency of trade.

Keywords: Intermediation Chains, Asymmetric Information, OTC Trading Networks, Order-Flow Agreements, Information Percolation

JEL Classification: G20, D82, D85

Suggested Citation

Glode, Vincent and Opp, Christian C., Adverse Selection and Intermediation Chains (May 16, 2014). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, American Economic Review, Available at SSRN: https://ssrn.com/abstract=3676653 or http://dx.doi.org/10.2139/ssrn.3676653

Vincent Glode (Contact Author)

University of Pennsylvania - The Wharton School ( email )

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

Christian C. Opp

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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