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Intermediation and price volatility

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  • Gehrig, Thomas
  • Ritzberger, Klaus

Abstract

This paper analyzes the role of intermediaries in providing immediacy in fast markets. Fast markets are modelled as contests with the possibility of multiple winners where the probability of casting the best quote depends on prior technology investments. Depending on the market design, equilibrium pricing by intermediaries involves a trade-off, between monopolistic price distortion and excess volatility. Since equilibrium at the pricing stage generates an externality, investments into faster trading technologies are necessarily asymmetric in equilibrium, akin to markets with vertical product differentiation. Further, equilibrium is not necessarily efficient, since it is possible that a high-cost intermediary ends up investing excessively and thus trades more frequently than low-cost rivals.

Suggested Citation

  • Gehrig, Thomas & Ritzberger, Klaus, 2022. "Intermediation and price volatility," Journal of Economic Theory, Elsevier, vol. 201(C).
    • Handle: RePEc:eee:jetheo:v:201:y:2022:i:c:s0022053122000321
    DOI: 10.1016/j.jet.2022.105442
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    Cited by:

    1. Dietrich, Diemo & Gehrig, Thomas, 2021. "Speculative and Precautionary Demand for Liquidity in Competitive Banking Markets," VfS Annual Conference 2021 (Virtual Conference): Climate Economics 242347, Verein für Socialpolitik / German Economic Association.

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    More about this item

    Keywords

    High-frequency trading; Intermediation; Market design; Price volatility;
    All these keywords.

    JEL classification:

    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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