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A theory of strategic intermediation and endogenous liquidity

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  • Rahi, Rohit
  • Zigrand, Jean-Pierre

Abstract

Market liquidity is typically characterized by a number of ad hoc metrics, such as depth (or market impact), volume, intermediation costs (such as breadth) etc. No general coherent denition seems to exist, and few attempts have been made to justify the existing metrics on welfare grounds. In this paper we propose a welfare-based denition of liquidity and characterize its relationship with the usual proxies. The model on which the welfare analysis rests is an equilibrium model with multiple assets and restricted investor participation. Strategic intermediaries pursue prot opportunities by providing intermedia- tion services (i.e. \liquidity") in exchange for an endogenous fee. Our model is well suited to study the contagion-like eects of liquidity shocks. We also consider the case in which intermediaries can optimally design securities.

Suggested Citation

  • Rahi, Rohit & Zigrand, Jean-Pierre, 2007. "A theory of strategic intermediation and endogenous liquidity," LSE Research Online Documents on Economics 4764, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:4764
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    File URL: http://eprints.lse.ac.uk/4764/
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    References listed on IDEAS

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    Cited by:

    1. Rohit Rahi & Jean-Pierre Zigrand, 2009. "Strategic Financial Innovation in Segmented Markets," The Review of Financial Studies, Society for Financial Studies, vol. 22(8), pages 2941-2971, August.
    2. Gianni De Nicolò & Iryna Ivaschenko, 2009. "Global Liquidity, Risk Premiums and Growth Opportunities," CESifo Working Paper Series 2598, CESifo.
    3. Rahi, Rohit & Zigrand, Jean-Pierre, 2008. "Arbitrage networks," LSE Research Online Documents on Economics 4787, London School of Economics and Political Science, LSE Library.

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    More about this item

    Keywords

    Liquidity; intermediation; arbitrage; restricted participation; con- tagion; market microstructure.;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)

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