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Optimal Market Size

  • Kei Kawakami

This paper studies endogenous market formation in a ?nancial trading model where strategic traders face information asymmetries and aggregate shocks. First, we show that negative participation externalities can arise for a large class of assets. In a decentralized process of market formation, the negative externalities limit competition between intermediaries. The model predicts that free entry into intermediation causes market fragmentation, but it is Pareto-superior to a single market. The model also predicts that the more intense the information asymmetry, the more a security tends to trade in fragmented markets.

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File URL: http://fbe.unimelb.edu.au/__data/assets/pdf_file/0006/796983/1168.pdf
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Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 1168.

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Length: 40 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:mlb:wpaper:1168
Contact details of provider: Postal:
Department of Economics, The University of Melbourne, 4th Floor, FBE Building, Level 4, 111 Barry Street. Victoria, 3010, Australia

Phone: +61 3 8344 5355
Fax: +61 3 8344 6899
Web page: http://fbe.unimelb.edu.au/economics
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  1. Diamond, Douglas W. & Verrecchia, Robert E., 1981. "Information aggregation in a noisy rational expectations economy," Journal of Financial Economics, Elsevier, vol. 9(3), pages 221-235, September.
  2. Ananth N. Madhavan, . "Trading Mechanisms in Securities Markets," Rodney L. White Center for Financial Research Working Papers 16-90, Wharton School Rodney L. White Center for Financial Research.
  3. Cantillon, Estelle & Yin, Pai-Ling, 2008. "Competition between Exchanges: Lessons from the Battle of the Bund," CEPR Discussion Papers 6923, C.E.P.R. Discussion Papers.
  4. José M. Marín & Rohit Rahi, 2000. "Information Revelation and Market Incompleteness," Review of Economic Studies, Oxford University Press, vol. 67(3), pages 563-579.
  5. O'Hara, Maureen & Ye, Mao, 2011. "Is market fragmentation harming market quality?," Journal of Financial Economics, Elsevier, vol. 100(3), pages 459-474, June.
  6. Foucault, Thierry & Menkveld, Albert J., 2006. "Competition for Order Flow and Smart Order Routing Systems," CEPR Discussion Papers 5523, C.E.P.R. Discussion Papers.
  7. Estelle Cantillon & Pai-Ling Yin, 2011. "Competition between Exchanges: A research Agenda," ULB Institutional Repository 2013/99386, ULB -- Universite Libre de Bruxelles.
  8. Spiegel, Matthew & Subrahmanyam, Avanidhar, 1992. "Informed Speculation and Hedging in a Noncompetitive Securities Market," Review of Financial Studies, Society for Financial Studies, vol. 5(2), pages 307-29.
  9. Biais, Bruno & Glosten, Larry & Spatt, Chester, 2005. "Market microstructure: A survey of microfoundations, empirical results, and policy implications," Journal of Financial Markets, Elsevier, vol. 8(2), pages 217-264, May.
  10. Jayant Vivek Ganguli & Liyan Yang, 2009. "Complementarities, Multiplicity, and Supply Information," Journal of the European Economic Association, MIT Press, vol. 7(1), pages 90-115, 03.
  11. Madhavan, Ananth, 2000. "Market microstructure: A survey," Journal of Financial Markets, Elsevier, vol. 3(3), pages 205-258, August.
  12. Pagano, Marco, 1986. "Trading Volume and Asset Liquidity," CEPR Discussion Papers 142, C.E.P.R. Discussion Papers.
  13. Albert S. Kyle, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Oxford University Press, vol. 56(3), pages 317-355.
  14. William O. Brown & J. Harold Mulherin & Marc D. Weidenmier, 2008. "Competing with the New York Stock Exchange," The Quarterly Journal of Economics, Oxford University Press, vol. 123(4), pages 1679-1719.
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