I present a general equilibrium theory of market formation. The structure of markets is not taken as a primitive, but rather as an outcome of the theory. A new class of decision-making agents is introduced, the marketmakers. The theory is then based on the information structure and the incentives of these marketmakers. First, a partial equilibrium information structure is assumed. Next, two polar cases of incentive structures for marketmakers are presented: monopoly and perfect competition. I then use the theory to give an explanation of missing markets. Examples are given where missing markets arise out of complementarities among marketmakers. These agents are rationally forecasting their projected demands and supplies. Too many markets may be formed when there are setup costs to setting up markets. This can happen despite rational profit calculations by the marketmakers.
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Franklin Allen, Douglas Gale, 1988.
"Optimal Security Design,"
Review of Financial Studies,
Oxford University Press for Society for Financial Studies, vol. 1(3), pages 229-263.
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