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Cream Skimming in Financial Markets

Author

Listed:
  • Patrick Bolton
  • Tano Santos
  • Jose A. Scheinkman

Abstract

We propose an equilibrium occupational choice model, where agents can choose to work in the real sector (become entrepreneurs) or to become informed dealers in financial markets. Agents incur costs to become informed dealers and develop skills for valuing assets up for trade. The financial sector comprises a transparent competitive exchange, where uninformed agents trade and an opaque over-the-counter (OTC) market, where informed dealers offer attractive terms for the most valuable assets entrepreneurs put up for sale. Thanks to their information advantage and valuation skills, dealers are able to provide incentives to entrepreneurs to originate good assets. However, the opaqueness of the OTC market allows dealers to extract informational rents from entrepreneurs. Trade in the OTC market imposes a negative externality on the organized exchange, where only the less valuable assets end up for trade. We show that in equilibrium the dealers' informational rents in the OTC market are too large and attract too much talent to the financial industry.

Suggested Citation

  • Patrick Bolton & Tano Santos & Jose A. Scheinkman, 2011. "Cream Skimming in Financial Markets," NBER Working Papers 16804, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:16804
    Note: CF
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    References listed on IDEAS

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    1. Dimitri Vayanos & Pierre-Olivier Weill, 2008. "A Search-Based Theory of the On-the-Run Phenomenon," Journal of Finance, American Finance Association, vol. 63(3), pages 1361-1398, June.
    2. Thomas Philippon & Ariell Reshef, 2009. "Wages and Human Capital in the U.S. Financial Industry: 1909-2006," NBER Working Papers 14644, National Bureau of Economic Research, Inc.
    3. Afonso, Gara, 2011. "Liquidity and congestion," Journal of Financial Intermediation, Elsevier, vol. 20(3), pages 324-360, July.
    4. Ricardo Lagos & Guillaume Rocheteau, 2009. "Liquidity in Asset Markets With Search Frictions," Econometrica, Econometric Society, vol. 77(2), pages 403-426, March.
    5. Lagos, Ricardo & Rocheteau, Guillaume & Weill, Pierre-Olivier, 2011. "Crises and liquidity in over-the-counter markets," Journal of Economic Theory, Elsevier, vol. 146(6), pages 2169-2205.
    6. Vincent Glode & Richard C. Green & Richard Lowery, 2012. "Financial Expertise as an Arms Race," Journal of Finance, American Finance Association, vol. 67(5), pages 1723-1759, October.
    Full references (including those not matched with items on IDEAS)

    More about this item

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G2 - Financial Economics - - Financial Institutions and Services
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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