On the Limits to Speculation in Centralized Versus Decentralized Market Regimes
Posted: 15 May 2004
Date Written: October 2003
Speculation creates an adverse selection cost for utility traders, who will choose not to trade if this cost exceeds the benefits of using the asset market. However, if they do not participate, the market collapses, since private informational one is not suffcient to create a motive for trade. There is, therefore, a limit to the number of speculative transactions that a given market can support. This paper compares this limit indecentralized, monopoly - intermediated and competitively - intermediated market regimes, finding that the second regime is best equipped to deal with speculation: an informed monopolist canp rice - discriminate investors and thus always avoid market breakdowns. These regimes are also compared in terms of welfare and trading volume. The analysis suggests a reason for the presence of intermediaries in financial markets.
Keywords: Speculation, adverse selection, centralized markets
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