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Tough Middlemen

Author

Listed:
  • guido menzio
  • Gregor Jarosch

    (Stanford University)

  • Maryam Farboodi

    (Princeton University)

Abstract

We study a decentralized asset market in the spirit of Duffie, Petersen and Garleanu (2005). Agents are heterogeneous with respect to their valuation of the asset, and with respect to their bargaining ability. Specifically, a tough agent can make a take-it-or-leave it offer to soft agents and (with probability 1/2) to another tough agent. A soft agent makes (with probability 1/2) a take-it-or-leave-it offer to another soft-agent. In this environment, we show that tough agents become intermediaries, in the sense that a tough agent buys and sells the asset from a soft agent even when the two have the same valuation. We show that, in the presence of transaction costs, the non-fundamental trades carried out by tough agents are socially inefficient. We then show that, if tough agents cannot distinguish the identity of their trading partners, then intermediaries do not trade with each other even when they have different valuations. The unexecuted fundamental trades between tough agents are a second source of inefficiency. Finally, we show that—if agents can choose whether to pay a cost to become tough—the equilibrium involves mixing: a positive measure of agents is soft and a positive measure of agents is tough.

Suggested Citation

  • guido menzio & Gregor Jarosch & Maryam Farboodi, 2016. "Tough Middlemen," 2016 Meeting Papers 1371, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:1371
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    References listed on IDEAS

    as
    1. Darrell Duffie & Piotr Dworczak & Haoxiang Zhu, 2017. "Benchmarks in Search Markets," Journal of Finance, American Finance Association, vol. 72(5), pages 1983-2044, October.
    2. Maryam Farboodi, 2014. "Intermediation and Voluntary Exposure to Counterparty Risk," 2014 Meeting Papers 365, Society for Economic Dynamics.
    3. Chang, Briana & Zhang, Shengxing, 2015. "Endogenous market making and network formation," LSE Research Online Documents on Economics 86275, London School of Economics and Political Science, LSE Library.
    4. Babus, Ana & Hu, Tai-Wei, 2017. "Endogenous intermediation in over-the-counter markets," Journal of Financial Economics, Elsevier, vol. 125(1), pages 200-215.
    5. Shengxing Zhang & Briana Chang, 2015. "Endogenous Market-making and Formation of Trading Links," 2015 Meeting Papers 1227, Society for Economic Dynamics.
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    Cited by:

    1. Zachary Bethune & Bruno Sultanum & Nicholas Trachter, 2019. "Asset Issuance in Over-the-Counter Markets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 33, pages 4-29, July.

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