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Non-Exclusive Contracts, Collateralized Trade, and a Theory of an Exchange

  • Yaron Leitner
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    Liquid markets where agents have limited capacity to sign exclusive contracts, as well as imperfect knowledge of previous transactions by others, raise the following risk: An agent can promise the same asset to multiple counterparties and subsequently default. I show that in such markets an exchange can arise as a very simple type of intermediary that improves welfare. In particular, the only role of the exchange here is to set limits on the number of contracts that agents can report to it. Furthermore, reporting can be voluntary, i.e., pairs of agents can enter contracts without reporting them to the exchange and the exchange cannot observe whether agents enter such contracts. Interestingly, to implement an equilibrium in which agents report all their trades (voluntarily), the exchange may need to set position limits that are non-binding in equilibrium. In addition, the exchange must not make reported trades public (i.e., it is not a bulletin board). An alternative to an exchange is collateralized trade, but this alternative is costly because of the opportunity cost of collateral. I also show that the gains from an exchange increase when markets are more liquid (in the sense that the fixed costs per trade are lower) or when agents have more intangible capital (i.e., reputation)

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    Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 397.

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    Date of creation: 11 Aug 2004
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    Handle: RePEc:ecm:nawm04:397
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    1. Brusco, Sandro & Jackson, Matthew O., 1999. "The Optimal Design of a Market," Journal of Economic Theory, Elsevier, vol. 88(1), pages 1-39, September.
    2. Tano Santos & José A. Scheinkman, 2000. "Competition Among Exchanges," CRSP working papers 514, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    3. Glosten, Lawrence R, 1994. " Is the Electronic Open Limit Order Book Inevitable?," Journal of Finance, American Finance Association, vol. 49(4), pages 1127-61, September.
    4. Bernheim, B. Douglas & Peleg, Bezalel & Whinston, Michael D., 1987. "Coalition-Proof Nash Equilibria I. Concepts," Journal of Economic Theory, Elsevier, vol. 42(1), pages 1-12, June.
    5. Herbert L. Baer & Virginia G. France & James T. Moser, 2001. "Opportunity cost and prudentiality: an analysis of collateral decisions in bilateral and multilateral settings," Working Paper Series WP-01-26, Federal Reserve Bank of Chicago.
    6. Stewart C. Myers & Raghuram G. Rajan, 1995. "The Paradox of Liquidity," NBER Working Papers 5143, National Bureau of Economic Research, Inc.
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    8. Holmstrom, B & Tirole, J, 1996. "Private and Public Supply of Liquidity," Working papers 96-21, Massachusetts Institute of Technology (MIT), Department of Economics.
    9. Townsend, Robert M, 1978. "Intermediation with Costly Bilateral Exchange," Review of Economic Studies, Wiley Blackwell, vol. 45(3), pages 417-25, October.
    10. Alberto Bisin & Adriano Rampini, 2006. "Exclusive contracts and the institution of bankruptcy," Economic Theory, Springer, vol. 27(2), pages 277-304, January.
    11. Christine A. Parlour & Uday Rajan, 2001. "Competition in Loan Contracts," American Economic Review, American Economic Association, vol. 91(5), pages 1311-1328, December.
    12. 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.
    13. Brennan, Michael J., 1986. "A theory of price limits in futures markets," Journal of Financial Economics, Elsevier, vol. 16(2), pages 213-233, June.
    14. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September.
    15. Seppi, Duane J, 1997. "Liquidity Provision with Limit Orders and a Strategic Specialist," Review of Financial Studies, Society for Financial Studies, vol. 10(1), pages 103-50.
    16. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
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