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An Information-Based Theory of Financial Intermediation

Author

Listed:
  • Zachary Bethune
  • Bruno Sultanum
  • Nicholas Trachter

Abstract

We advance a theory of how private information and heterogeneous screening ability across market participants shapes trade in decentralized asset markets. We solve for the equilibrium market structure and show that the investors who intermediate trade the most and interact with the largest set of counterparties must have the highest screening ability. That is, the primary intermediaries are those with superior information?screening experts. We provide empirical support for the model?s predictions using transaction-level micro data and information disclosure requirements. Finally, we study the connection between screening ability and efficiency, and observe that a market where all investors are screening experts?and thus, a market with no private information?may be dominated in terms of welfare by a market with no screening experts.

Suggested Citation

  • Zachary Bethune & Bruno Sultanum & Nicholas Trachter, 2019. "An Information-Based Theory of Financial Intermediation," Working Paper 19-12, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:19-12
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    References listed on IDEAS

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    Cited by:

    1. Lester, Benjamin & Weill, Pierre-Olivier & Hugonnier, Julien, 2022. "Heterogeneity in decentralized asset markets," Theoretical Economics, Econometric Society, vol. 17(3), July.
    2. Jérôme Dugast & Semih Üslü & Pierre-Olivier Weill, 2022. "A Theory of Participation in OTC and Centralized Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 89(6), pages 3223-3266.
    3. Pierre-Olivier Weill, 2020. "The search theory of OTC markets," NBER Working Papers 27354, National Bureau of Economic Research, Inc.
    4. Gabrovski, Miroslav & Kospentaris, Ioannis, 2021. "Intermediation in over-the-counter markets with price transparency," Journal of Economic Theory, Elsevier, vol. 198(C).
    5. Lester, Benjamin & Shourideh, Ali & Venkateswaran, Venky & Zetlin-Jones, Ariel, 2023. "Market-making with search and information frictions," Journal of Economic Theory, Elsevier, vol. 212(C).

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    More about this item

    Keywords

    Over-the-counter markets; intermediation; private information;
    All these keywords.

    JEL classification:

    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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