Working Paper: CEPR ID: DP10850
Authors: Andrea Attar; Thomas Mariotti; François Salanié
Abstract: Many financial markets rely on a discriminatory limit-order book to balance supply and demand. We study these markets in a static model in which uninformed market makers compete in nonlinear tariffs to trade with an informed insider, as in Glosten (1994), Biais, Martimort, and Rochet (2000), and Back and Baruch (2013). We analyze the case where tariffs are unconstrained and the case where tariffs are restricted to be convex. In both cases, we show that pure-strategy equilibrium tariffs must be linear and, moreover, that such equilibria only exist under exceptional circumstances. These results cast doubt on the stability of even well-organized financial markets.
Keywords: Adverse Selection; Competing Mechanisms; Limit-Order Book
JEL Codes: D43; D82; D86
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| market makers' pricing strategies (D49) | behavior of informed insiders (G14) |
| convex tariffs (F14) | linear pricing in equilibrium (D41) |
| linear pricing (D41) | market makers adjust pricing strategies based on insider's type (D43) |
| no adverse selection and constant unit costs (D41) | existence of equilibria with nondecreasing individual quantities (C62) |
| multiple insider types (Y90) | market breakdown (G10) |
| convex tariffs (F14) | nondecreasing individual quantities (C69) |