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On the Limits to Speculation in Centralized versus Decentralized Market Regimes

  • Felipe Zurita

    ()

    (Instituto de Economía. Pontificia Universidad Católica de Chile.)

Speculation creates an adverse selection cost for utility traders, who will choose not to trade if this cost exceeds the benefits of using the asset market. However, if they do not participate, the market collapses, since private information alone is not sufficient to create a motive for trade. Therefore, there is a limit to the amount of speculative transactions that a given market can support. We compare this limit in decentralized versus centralized market regimes, finding that the centralized regime is more prone to speculation than the decentralized one: the transaction fees charged by an intermediary diminish the individual return to information, so that for a fixed value of trading, more speculative transactions can be supported. The analysis also suggests a reason for the existence of intermediaries in financial markets.

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Paper provided by Instituto de Economia. Pontificia Universidad Católica de Chile. in its series Documentos de Trabajo with number 196.

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Date of creation: 2001
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Publication status: Published as "On the Limits to Speculation in Centralized vs. Decentralized Market Regimes", Journal of Financial Intermediation 13, pp. 378-408, 2004.
Handle: RePEc:ioe:doctra:196
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