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A Model of Secular Migration from Centralized to Decentralized Trade

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Listed:
  • Zhifeng Cai

    (Rutgers University)

  • Feng Dong

    (Tsinghua University)

Abstract

A large number of financial assets are traded in both exchanges and over-the-counter markets (i.e., centralized and decentralized markets, CM and DM hereafter, respectively). Moreover, as documented by Biais and Green (Rev Econ Dyn 33:250–271, 2019), the twentieth century has witnessed a secular migration of asset trade from CM to DM. To this end, this paper develops a tractable model on strategic selection of venue trading to study the causes and consequences of the endogenous coexistence of CM and DM. In the model, traders’ choice of venue is shaped by the trade-off between information frictions in the CM and matching frictions in the DM. Closed-form solutions are obtained and used to characterize the endogenous share of trade across the two venues. We then use the model to evaluate two potential explanations of the migration from CM to DM: improvements in matching technologies and increases in the number of institutional investors. Surprisingly, while both forces could lead to more trade in DM, there exist parameter regions where the increase in the number of institutional investors leads to less trade in DM. We also obtain empirically testable implications that differentiate the two explanations.

Suggested Citation

  • Zhifeng Cai & Feng Dong, 2021. "A Model of Secular Migration from Centralized to Decentralized Trade," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 72(1), pages 201-244, July.
    • Handle: RePEc:spr:joecth:v:72:y:2021:i:1:d:10.1007_s00199-020-01280-2
    DOI: 10.1007/s00199-020-01280-2
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    More about this item

    Keywords

    Exchange versus over-the-counter (OTC) Market; Adverse selection; Search frictions; Institutional investors; Fragmented financial markets;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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