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The double bind of asymmetric information in over-the-counter markets

Author

Listed:
  • Taneli Mäkinen

    () (Bank of Italy)

  • Francesco Palazzo

    () (Bank of Italy)

Abstract

In over-the-counter markets with heterogeneous asset qualities and individual valuations, private information about both of these value components amplifies the adverse selection problem attributable only to privately known asset quality. Specifically, when gains from trade are low, asymmetric information creates a double bind: either the market breaks down due to a classic lemons problem or low-quality assets are traded excessively, generating a congestion externality. A market designer may improve efficiency without incurring losses by acquiring all assets, issuing asset-backed securities of publicly known quality and capturing at least a part of the surplus from the future trades of these securities.

Suggested Citation

  • Taneli Mäkinen & Francesco Palazzo, 2017. "The double bind of asymmetric information in over-the-counter markets," Temi di discussione (Economic working papers) 1128, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_1128_17
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    File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/2017/2017-1128/en_tema_1128.pdf
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    References listed on IDEAS

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    Cited by:

    1. Vladimir Asriyan & William Fuchs & Brett Green, 2017. "Sentiment, liquidity and asset prices," Economics Working Papers 1583, Department of Economics and Business, Universitat Pompeu Fabra.

    More about this item

    Keywords

    asymmetric information; over-the-counter markets; search frictions; market design;

    JEL classification:

    • 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
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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