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Legal Protection in Retail Financial Markets

  • Bruce I. Carlin
  • Simon Gervais

Given the importance of sound advice in retail financial markets and the fact that financial institutions outsource their advice services, what legal rules maximize social welfare in the market? We address this question by posing a theoretical model of retail markets in which a firm and a broker face a bilateral hidden action problem when they service clients in the market. All participants in the market are rational, and prices are set based on consistent beliefs about equilibrium actions of the firm and the broker. We characterize the optimal law within our modeling context, and derive how the legal system splits the blame between parties to the transaction. We also analyze how complexity in assessing clients and conflicts of interest affect the law. Since these markets are large, the implications of the analysis have great welfare import.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14972.

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Date of creation: May 2009
Publication status: published as Legal Protection in Retail Financial Markets (with Simon Gervais). Review of Corporate Finance Studies 1: 68-108, 2012.
Handle: RePEc:nbr:nberwo:14972
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