Information Aggregation and Optimal Market Size

No 1182, Department of Economics - Working Papers Series from The University of Melbourne

Abstract: This paper studies a rational expectations model of trading where strategic traders face information asymmetries and endowment shocks. We show that negative partici- pation externalities arise due to an endogenous interaction between information aggre-gation and multiple trading motives. Moreover, the negative externalities are strong enough to make optimal market size ?nite. In a decentralized process of market for- mation, multiple markets can survive due to the negative externalities among traders. The model also predicts: (i) that only in a su¢ ciently large market the equilibrium multiplicity due to self-ful?lling trading motives can arise, (ii) that a high correlation in endowment shocks can make markets extremely illiquid.

Keywords: Asymmetric information; Aggregate shock; Imperfect competition; Market fragmentation; Multiple equilibria; Network externality puzzle; Price impact. (search for similar items in EconPapers)
Pages: 101 pages
Date: 2014
New Economics Papers: this item is included in nep-cta, nep-mic, nep-mst, nep-net and nep-ure
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:mlb:wpaper:1182

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