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Financial Expertise as an Arms Race

Author

Listed:
  • Glode, V.
  • Green, R.C.
  • Lowery, R.

Abstract

We propose a model in which firms involved in trading securities overinvest in financial expertise. Intermediaries or traders in the model meet and bargain over a financial asset. As in the bargaining model in Dang (2008), counterparties endogenously decide whether to acquire information, and improve their bargaining positions, even though the information creates adverse selection. We add to this setting the concept of "financial expertise" as resources invested to lower the cost of later acquiring information about the value of the asset being traded. These investments are made before the parties know about their role in the bargaining game, as proposer or responder, buyer or seller. A prisoner's dilemma arises because investments to lower information acquisition costs improve bargaining outcomes given the other party's information costs, even though the information has no social benefit. These investments lead to breakdowns in trade, or liquidity crises, in response to random but infrequent increases in asset volatility
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Suggested Citation

  • Glode, V. & Green, R.C. & Lowery, R., 2010. "Financial Expertise as an Arms Race," Discussion Paper 2010-87S, Tilburg University, Center for Economic Research.
    • Handle: RePEc:tiu:tiucen:7f1ffc85-7ad2-4d99-82a2-ba1480720daa
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    References listed on IDEAS

    as
    1. Kevin M. Murphy & Andrei Shleifer & Robert W. Vishny, 1991. "The Allocation of Talent: Implications for Growth," The Quarterly Journal of Economics, Oxford University Press, vol. 106(2), pages 503-530.
    2. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-574, September.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Financial services; over-the-counter markets; financial crisis;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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