Intermediaries as Information Aggregators

In most theories of financial intermediation, the intermediaries diversify risk, transform maturity or liquidity, or screen/monitor borrowers. But in U.S. Treasury auctions, none of these rationales apply: Investors can bid directly, assets are highly liquid, dealers do not discipline, screen or diversify fiscal policy risk. Yet, most bids are still intermediated. Motivated by treasury auctions, we explore a new information aggregation theory of intermediaries who observe the order-flow of each client and use that aggregated information to advise all clients. In contrast to underwriting theories where intermediaries extract rents, but reduce revenue variance, information aggregators do the opposite: They increase expected auction revenue, but also make the revenue more sensitive to changes in asset value. We use the model to examine current policy questions, such as the optimal number of intermediaries, the effect of non-intermediated bids and minimum bidding requirements.