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Markets for Financial Innovation

Author

Listed:
  • Ana Babus

    (Washington University in St. Louis)

  • Kinda Hachem

    (University of Chicago)

Abstract

Regulators have pushed for centralized trading as a way to increase transparency following the recent financial crisis. However, the nature of the security being traded may change when the market structure in which it trades is forced to change. In this paper, we develop a model to explore interactions between market formation and the design of new financial securities. Our results rationalize why debt contracts are frequently traded in over-the-counter markets whereas equity is typically traded on exchanges. We also find that regulations promoting universally larger markets can reduce investor welfare by reducing the production of securities with less variable payoffs.

Suggested Citation

  • Ana Babus & Kinda Hachem, 2018. "Markets for Financial Innovation," 2018 Meeting Papers 355, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:355
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    References listed on IDEAS

    as
    1. Xavier Vives, 2011. "Strategic Supply Function Competition With Private Information," Econometrica, Econometric Society, vol. 79(6), pages 1919-1966, November.
    2. Bruno Biais & Richard Green, 2019. "The Microstructure of the Bond Market in the 20th Century," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 250-271, July.
    3. Jérôme Dugast & Semih Uslu & Pierre-Olivier Weil, 2018. "Platform Trading with an OTC Market Fringe," Post-Print hal-02104107, HAL.
    4. Bruno Biais & Thomas Mariotti, 2005. "Strategic Liquidity Supply and Security Design," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 72(3), pages 615-649.
    5. Ulf Axelson, 2007. "Security Design with Investor Private Information," Journal of Finance, American Finance Association, vol. 62(6), pages 2587-2632, December.
    6. Duffie Darrell & Rahi Rohit, 1995. "Financial Market Innovation and Security Design: An Introduction," Journal of Economic Theory, Elsevier, vol. 65(1), pages 1-42, February.
    7. Albert S. Kyle, 1989. "Informed Speculation with Imperfect Competition," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 56(3), pages 317-355.
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    Citations

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    Cited by:

    1. Jérôme Dugast & Semih Üslü & Pierre-Olivier Weill, 2022. "A Theory of Participation in OTC and Centralized Markets [Trade Dynamics in the Market for Federal Funds]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 89(6), pages 3223-3266.
    2. Thomas M. Eisenbach & Gregory Phelan, 2022. "Cournot Fire Sales," American Economic Journal: Macroeconomics, American Economic Association, vol. 14(3), pages 508-542, July.

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    More about this item

    JEL classification:

    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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