Working Paper: CEPR ID: DP1648
Authors: Thomas Gehrig; Matthew Jackson
Abstract: We examine the bid-ask quotes offered by specialists (or dealers) who face indirect competition from other specialists who trade in related assets. In the context of a simple model where investors have mean variance preferences, we characterize the equilibrium bids and asks quoted by K specialists in N assets, where some specialists may control more than one asset. We compare the equilibrium spreads as the number (and factor structure) of the assets each specialist controls is varied. It is shown that for some constellations of initial portfolio holdings and asset covariance it is socially preferable to have competing specialists, while for others it is socially preferable to have their actions coordinated (or to have one specialist control several assets). In a simple factor model, we show how the optimal specialist control structure depends on whether the assets trade as substitutes or complements. In some situations it is beneficial to have specialist power concentrated within industries, in other situations, across industries, and in yet other situations, not to be concentrated at all.
Keywords: bid-ask spreads; multisecurity markets; market structure; indirect competition
JEL Codes: D43; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| indirect competition among specialists (L49) | narrow bid-ask spreads (G19) |
| indirect competition among specialists (L49) | improve welfare (I30) |
| positive correlation of assets (C10) | narrow bid-ask spreads (G19) |
| single specialist controlling both assets (G29) | lower spreads (G19) |
| complementary demands of assets (D10) | single specialist preferable (I11) |
| substitutable assets (G19) | independent ownership preferable (J54) |