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Non-Exclusive Contracts, Collateralized Trade, and a Theory of an Exchange

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  • Yaron Leitner
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    Abstract

    Liquid markets where agents have limited capacity to sign exclusive contracts, as well as imperfect knowledge of previous transactions by others, raise the following risk: An agent can promise the same asset to multiple counterparties and subsequently default. I show that in such markets an exchange can arise as a very simple type of intermediary that improves welfare. In particular, the only role of the exchange here is to set limits on the number of contracts that agents can report to it. Furthermore, reporting can be voluntary, i.e., pairs of agents can enter contracts without reporting them to the exchange and the exchange cannot observe whether agents enter such contracts. Interestingly, to implement an equilibrium in which agents report all their trades (voluntarily), the exchange may need to set position limits that are non-binding in equilibrium. In addition, the exchange must not make reported trades public (i.e., it is not a bulletin board). An alternative to an exchange is collateralized trade, but this alternative is costly because of the opportunity cost of collateral. I also show that the gains from an exchange increase when markets are more liquid (in the sense that the fixed costs per trade are lower) or when agents have more intangible capital (i.e., reputation)

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    File URL: http://repec.org/esNAWM04/up.2219.1049146905.pdf
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    Bibliographic Info

    Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 397.

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    Date of creation: 11 Aug 2004
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    Handle: RePEc:ecm:nawm04:397

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    Keywords: Theory of financial intermediation; Financial contracting with non-exclusivity;

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    1. Bengt Holmstrom & Jean Tirole, 1996. "Private and Public Supply of Liquidity," NBER Working Papers 5817, National Bureau of Economic Research, Inc.
    2. T. Santos & J. Scheinkman, 2000. "Competition Among Exchanges," Princeton Economic Theory Papers 00s12, Economics Department, Princeton University.
    3. Alberto Bisin & Adriano Rampini, 2006. "Exclusive contracts and the institution of bankruptcy," Economic Theory, Springer, vol. 27(2), pages 277-304, January.
    4. Stewart C. Myers & Raghuram G. Rajan, 1995. "The Paradox of Liquidity," NBER Working Papers 5143, National Bureau of Economic Research, Inc.
    5. Sandro Brusco & Matthew O. Jackson, 1997. "The Optimal Design of a Market," Microeconomics 9711003, EconWPA.
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    9. Herbert L. Baer & Virginia G. France & James T. Moser, 2001. "Opportunity cost and prudentiality: an analysis of collateral decisions in bilateral and multilateral settings," Working Paper Series WP-01-26, Federal Reserve Bank of Chicago.
    10. Pagano, Marco & Roell, Ailsa, 1996. " Transparency and Liquidity: A Comparison of Auction and Dealer Markets with Informed Trading," Journal of Finance, American Finance Association, vol. 51(2), pages 579-611, June.
    11. Townsend, Robert M, 1978. "Intermediation with Costly Bilateral Exchange," Review of Economic Studies, Wiley Blackwell, vol. 45(3), pages 417-25, October.
    12. Seppi, Duane J, 1997. "Liquidity Provision with Limit Orders and a Strategic Specialist," Review of Financial Studies, Society for Financial Studies, vol. 10(1), pages 103-50.
    13. Brennan, Michael J., 1986. "A theory of price limits in futures markets," Journal of Financial Economics, Elsevier, vol. 16(2), pages 213-233, June.
    14. Bernheim, B. Douglas & Peleg, Bezalel & Whinston, Michael D., 1987. "Coalition-Proof Nash Equilibria I. Concepts," Journal of Economic Theory, Elsevier, vol. 42(1), pages 1-12, June.
    15. Glosten, Lawrence R, 1994. " Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-61, September.
    16. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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