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Cream Skimming in Financial Markets

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  • Patrick Bolton
  • Tano Santos
  • Jose A. Scheinkman

Abstract

We propose an equilibrium occupational choice model, where agents can choose to work in the real sector (become entrepreneurs) or to become informed dealers in financial markets. Agents incur costs to become informed dealers and develop skills for valuing assets up for trade. The financial sector comprises a transparent competitive exchange, where uninformed agents trade and an opaque over-the-counter (OTC) market, where informed dealers offer attractive terms for the most valuable assets entrepreneurs put up for sale. Thanks to their information advantage and valuation skills, dealers are able to provide incentives to entrepreneurs to originate good assets. However, the opaqueness of the OTC market allows dealers to extract informational rents from entrepreneurs. Trade in the OTC market imposes a negative externality on the organized exchange, where only the less valuable assets end up for trade. We show that in equilibrium the dealers' informational rents in the OTC market are too large and attract too much talent to the financial industry.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16804.

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Date of creation: Feb 2011
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Handle: RePEc:nbr:nberwo:16804

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  1. Philippon, Thomas & Reshef, Ariell, 2009. "Wages and Human Capital in the U.S. Financial Industry: 1909-2006," CEPR Discussion Papers 7282, C.E.P.R. Discussion Papers.
  2. Ricardo Lagos & Guillaume Rocheteau & Pierre-Olivier Weill, 2009. "Crises and Liquidity in Over-the-Counter Markets," NBER Working Papers 15414, National Bureau of Economic Research, Inc.
  3. Pierre-Olivier Weill & Dimitri Vayanos, 2007. "A Search-Based Theory of the On-the-Run Phenomenon," FMG Discussion Papers dp577, Financial Markets Group.
  4. Gara M. Afonso, 2008. "Liquidity and congestion," Staff Reports 349, Federal Reserve Bank of New York.
  5. Guillaume Rocheteau & Ricardo Lagos, 2008. "Liquidity in asset markets with search frictions," Working Paper 0804, Federal Reserve Bank of Cleveland.
  6. Vincent Glode & Richard C. Green & Richard Lowery, 2012. "Financial Expertise as an Arms Race," Journal of Finance, American Finance Association, vol. 67(5), pages 1723-1759, October.
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Cited by:
  1. Beck, Thorsten & Degryse, Hans & Kneer, Christiane, 2012. "Is more finance better? Disentangling intermediation and size effects of financial systems," Open Access publications from Katholieke Universiteit Leuven urn:hdl:123456789/353769, Katholieke Universiteit Leuven.

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