Implicit Collusion on Wide Spreads
Posted: 26 Apr 1998
Recent empirical findings suggest that spreads quoted in dealership markets might be uncompetitive. This paper analyzes theoretically if price competition between risk-averse market-makers leaves room for implicit collusive behavior. We compare the spread and risk-sharing efficiency arising in several market structures differing in terms of i) the priority rule followed in case of ties, and ii) the type of schedules market-makers may use, namely: general schedules, linear schedules, or limit orders. In general, competitive pricing does not arise in equilibrium, and there is a conflict between risk-sharing efficiency and the tightness of the spread. This conflict can be mitigated by an appropriate market structure design. The limit order market is the only market structure in which the competitive equilibrium is the unique equilibrium.
JEL Classification: D40
Suggested Citation: Suggested Citation