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Competition between market-making Intermediaries

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  • Simon Loertscher
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    Abstract

    We introduce capacity constrained competition between market-making intermediaries in a model in which agents can choose between trading with intermediaries, joining a search market or remaining inactive. Recently, market-making by a monopolistic intermediary has been analyzed by Rust and Hall (2003) and Gehrig (1993). Market-makers set publicly observable ask and bid prices. Because market-making involves price setting, without further restrictions competition between market-making intermediaries is Bertrand-like and yields the Walrasian outcome, where the ask-bid spread is zero (Rust and Hall 2003, Gehrig 1993). However, positive ask-bid spreads and competition between market-makers can be observed in reality, e.g. in banking and in retailing. Following Kreps and Scheinkman (1983) and Boccard and Wauthy (2000), we therefore introduce physical capacity constraints. This allows for a gradual transition from monopolistic to perfectly competitive intermediation as the number of intermediaries increases. In particular, we show that given Cournot capacities, intermediaries will set Cournot bid and ask prices in the subsequent subgames, so that the equilibrium of the intermediated market coincides with the Walrasian equilibrium as the number of intermediaries becomes large

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    Bibliographic Info

    Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 515.

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    Date of creation: 11 Aug 2004
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    Handle: RePEc:ecm:nasm04:515

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    Keywords: Market-making; capacity constrained competition; market microstructure;

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    1. Daniel F. Spulber, 1996. "Market Microstructure and Intermediation," Journal of Economic Perspectives, American Economic Association, vol. 10(3), pages 135-152, Summer.
    2. Stahl, Dale O, II, 1988. "Bertrand Competition for Inputs and Walrasian Outcomes," American Economic Review, American Economic Association, vol. 78(1), pages 189-201, March.
    3. repec:rus:hseeco:72158 is not listed on IDEAS
    4. John Rust & George Hall, 2003. "Middlemen versus Market Makers: A Theory of Competitive Exchange," Journal of Political Economy, University of Chicago Press, vol. 111(2), pages 353-403, April.
    5. Spulber, Daniel F, 1996. "Market Making by Price-Setting Firms," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 559-80, October.
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