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Can competition between brokers mitigate agency conflicts with their customers?

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  • Sugato Chakravarty
  • Asani Sarkar

Abstract

We study competitive, but strategic, brokers executing trades for an informed trader in multi-period setting. The brokers can choose to (a) execute the order, as agents, first, and trade for themselves as dealers, afterwards; or (b) trade for themselves first and execute the order later. We show that the equilibrium outcome depends on the number of brokers. When the number of brokers exceeds a critical number (greater than one), the informed trader distributes his order (equally) among the available brokers. The brokers, in turn, execute the informed trader's order first and trade personal quantities, as dealers, afterwards. When the number of brokers is below this critical value, the informed trader gives his order to a single broker, who, in turn, trades personal quantities as a dealer first and executes the informed trader's order second. Since the informed trader is hurt in the latter case, he prefers markets with many brokers. Thus, regulators can mitigate trading abuses arising from a conflict of interest between brokers as an alternative to banning such practices. We empirically show that the critical number of brokers for the favorable competitive equilibrium appears to be satisfied for the futures contracts in our sample.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Research Paper with number 9705.

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Date of creation: 1997
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Handle: RePEc:fip:fednrp:9705

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Keywords: Stock market ; Competition;

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  1. Roell, Ailsa, 1990. "Dual-capacity trading and the quality of the market," Journal of Financial Intermediation, Elsevier, vol. 1(2), pages 105-124, June.
  2. Fishman, Michael J & Longstaff, Francis A, 1992. " Dual Trading in Futures Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 643-71, June.
  3. Benveniste, Lawrence M. & Marcus, Alan J. & Wilhelm, William J., 1992. "What's special about the specialist?," Journal of Financial Economics, Elsevier, vol. 32(1), pages 61-86, August.
  4. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  5. Sarkar Asani, 1995. "Dual Trading: Winners, Losers, and Market Impact," Journal of Financial Intermediation, Elsevier, vol. 4(1), pages 77-93, January.
  6. Madrigal, Vicente, 1996. " Non-fundamental Speculation," Journal of Finance, American Finance Association, vol. 51(2), pages 553-78, June.
  7. Kandel, Eugene & Pearson, Neil D, 1995. "Differential Interpretation of Public Signals and Trade in Speculative Markets," Journal of Political Economy, University of Chicago Press, vol. 103(4), pages 831-72, August.
  8. Sanford J. Grossman, . "An Economic Analysis of Dual Trading," Rodney L. White Center for Financial Research Working Papers 33-89, Wharton School Rodney L. White Center for Financial Research.
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