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Information Aggregation and Optimal Market Size

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  • Kei Kawakami

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.

Suggested Citation

  • Kei Kawakami, 2014. "Information Aggregation and Optimal Market Size," Department of Economics - Working Papers Series 1182, The University of Melbourne.
    • Handle: RePEc:mlb:wpaper:1182
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    References listed on IDEAS

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    Cited by:

    1. Jérôme Dugast & Semih Uslu & Pierre-Olivier Weil, 2018. "Platform Trading with an OTC Market Fringe," Post-Print hal-02104107, HAL.
    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.

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    Keywords

    Asymmetric information; Aggregate shock; Imperfect competition; Market fragmentation; Multiple equilibria; Network externality puzzle; Price impact.;
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