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The Optimal Design of a Market

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  • Matthew O. Jackson
  • Sandro Brusco

Abstract

We study the optimal design of the rules of trade in a two-period market given that agents arrive at different times and may only trade with agents present contemporaneously. First period agents face a fixed cot of trading across periods, and their decisions of whether or not to trade in the second period result in externalities relative to the agents arriving in the second period. Given the non-convexities associated with the fixed cost, competitve trading rules can result in inefficienceis in such a market and, in fact, anonymity must be sacrificed to achieve efficiency. Efficient trading rules have a market maker (i.e., an agent who is given some market power and the right to trade across periods) who faces some competition within period trading, but not across periods. The efficient choice of who should be market maker can be made by auctionaing rights to this position. If there is uncertainty across periods, then efficient mechanisms may involve multiple market makers, and the optimal number of market makers depends on the cost of trading, level of risk aversion, and presence of scymmetric information.

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Bibliographic Info

Paper provided by Northwestern University, Center for Mathematical Studies in Economics and Management Science in its series Discussion Papers with number 1186.

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Date of creation: Apr 1997
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Handle: RePEc:nwu:cmsems:1186

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Postal: Center for Mathematical Studies in Economics and Management Science, Northwestern University, 580 Jacobs Center, 2001 Sheridan Road, Evanston, IL 60208-2014
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Web page: http://www.kellogg.northwestern.edu/research/math/
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References

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  1. Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Baliga, Sandeep & Corchon, Luis C. & Sjostrom, Tomas, 1997. "The Theory of Implementation When the Planner Is a Player," Journal of Economic Theory, Elsevier, vol. 77(1), pages 15-33, November.
  3. Matthew 0. Jackson, 1989. "Implementation in Undominated Strategies - A Look at Bounded Mechanisms," Discussion Papers 833, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  4. Madhavan, Ananth, 1992. " Trading Mechanisms in Securities Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 607-41, June.
  5. Bhaskar Dutta & Arunava Sen & Rajiv Vohra, 1994. "Nash implementation through elementary mechanisms in economic environments," Review of Economic Design, Springer, vol. 1(1), pages 173-203, December.
  6. Thomas Gehrig & Matthew Jackson, 1994. "Bid-Ask Spreads with Indirect Competition Among Specialists," Discussion Papers 1107, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  7. Kyle, Albert S, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Wiley Blackwell, vol. 56(3), pages 317-55, July.
  8. Gehrig, Thomas, 1993. "Intermediation in Search Markets," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 2(1), pages 97-120, Spring.
  9. Bernhardt, Dan & Hughson, Eric, 1996. "Discrete Pricing and the Design of Dealership Markets," Journal of Economic Theory, Elsevier, vol. 71(1), pages 148-182, October.
  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. Hurwicz, L, 1979. "Outcome Functions Yielding Walrasian and Lindahl Allocations at Nash Equilibrium Points," Review of Economic Studies, Wiley Blackwell, vol. 46(2), pages 217-25, April.
  12. Matthew O. Jackson & Thomas R. Palfrey, 1997. "Efficiency and Voluntary Implementation in Markets with Repeated Pairwise Bargaining," Game Theory and Information 9711003, EconWPA.
  13. Schmeidler, David, 1980. "Walrasian Analysis via Strategic Outcome Functions," Econometrica, Econometric Society, vol. 48(7), pages 1585-93, November.
  14. Roberto Serrano & Rajiv Vohra, 1997. "Non-cooperative implementation of the core," Social Choice and Welfare, Springer, vol. 14(4), pages 513-525.
  15. Glover Jonathan, 1994. "A Simpler Mechanism That Stops Agents from Cheating," Journal of Economic Theory, Elsevier, vol. 62(1), pages 221-229, February.
  16. Moore, John & Repullo, Rafael, 1988. "Subgame Perfect Implementation," Econometrica, Econometric Society, vol. 56(5), pages 1191-1220, September.
  17. Peck, James, 1990. "Liquidity without money: A General equilibrium model of market microstructure," Journal of Financial Intermediation, Elsevier, vol. 1(1), pages 80-103, March.
  18. Saijo, Tatsuyoshi & Tatamitani, Yoshikatsu & Yamato, Takehiko, 1996. "Toward Natural Implementation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(4), pages 949-80, November.
  19. Lu Hong, 1996. "Bayesian implementation in exchange economies with state dependent feasible sets and private information," Social Choice and Welfare, Springer, vol. 13(4), pages 433-444.
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Citations

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Cited by:
  1. Yaron Leitner, 2010. "Inducing agents to report hidden trades: a theory of an intermediary," Working Papers 10-28, Federal Reserve Bank of Philadelphia.
  2. Deneckere,R. & Peck,J., 1998. "Demand uncertainty, endogenous timing and costly waiting : jumping the gun in competitive markets," Working papers 22, Wisconsin Madison - Social Systems.
  3. Yaron Leitner, 2009. "Inducing agents to report hidden trades: a theory of an intermediary," Working Papers 09-10, Federal Reserve Bank of Philadelphia.
  4. Gehrig, Thomas & Jackson, Matthew, 1998. "Bid-ask spreads with indirect competition among specialists," Journal of Financial Markets, Elsevier, vol. 1(1), pages 89-119, April.
  5. Matthew O. Jackson, 2001. "A crash course in implementation theory," Social Choice and Welfare, Springer, vol. 18(4), pages 655-708.
  6. Yaron Leitner, 2004. "Non-Exclusive Contracts, Collateralized Trade, and a Theory of an Exchange," Econometric Society 2004 North American Winter Meetings 397, Econometric Society.
  7. Matthew O. Jackson & Thomas R. Palfrey, 1998. "Efficiency and Voluntary Implementation in Markets with Repeated Pairwise Bargaining," Econometrica, Econometric Society, vol. 66(6), pages 1353-1388, November.
  8. Yaron Leitner, 2005. "A theory of an intermediary with nonexclusive contracting," Working Papers 05-12, Federal Reserve Bank of Philadelphia.
  9. Comerton-Forde, Carole & Rydge, James, 2006. "The current state of Asia-Pacific stock exchanges: A critical review of market design," Pacific-Basin Finance Journal, Elsevier, vol. 14(1), pages 1-32, January.
  10. Jan-Peter Siedlarek, 2012. "Intermediation in Networks," Working Papers 2012.42, Fondazione Eni Enrico Mattei.
  11. Huang, Jennifer & Wang, Jiang, 2010. "Market liquidity, asset prices, and welfare," Journal of Financial Economics, Elsevier, vol. 95(1), pages 107-127, January.
  12. Jennifer Huang & Jiang Wang, 2008. "Market Liquidity, Asset Prices and Welfare," NBER Working Papers 14058, National Bureau of Economic Research, Inc.
  13. Yaron Leitner, 2003. "Non-exclusive contracts, collateralized trade, and a theory of an exchange," Working Papers 03-3, Federal Reserve Bank of Philadelphia.

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