Cream Skimming in Financial Markets

Working Paper: NBER ID: w16804

Authors: Patrick Bolton; Tano Santos; Jose A. Scheinkman

Abstract: We propose an equilibrium occupational choice model, where agents can choose to work in the real sector (become entrepreneurs) or to become informed dealers in financial markets. Agents incur costs to become informed dealers and develop skills for valuing assets up for trade. The financial sector comprises a transparent competitive exchange, where uninformed agents trade and an opaque over-the-counter (OTC) market, where informed dealers offer attractive terms for the most valuable assets entrepreneurs put up for sale. Thanks to their information advantage and valuation skills, dealers are able to provide incentives to entrepreneurs to originate good assets. However, the opaqueness of the OTC market allows dealers to extract informational rents from entrepreneurs. Trade in the OTC market imposes a negative externality on the organized exchange, where only the less valuable assets end up for trade. We show that in equilibrium the dealers' informational rents in the OTC market are too large and attract too much talent to the financial industry.

Keywords: Financial Markets; Occupational Choice; Information Rents

JEL Codes: G1; G14; G18; G2; G24; G28

Causal Claims

Cause	Effect
informed dealers in the OTC market (G18)	excessive informational rents (D89)
excessive informational rents (D89)	attraction of talent to the financial sector (G29)
informed dealers in the OTC market (G18)	negative impact on organized exchanges (G10)
number of informed dealers increases (G14)	cream skimming (D49)
cream skimming (D49)	reduction in quality of assets in organized market (L15)
reduction in quality of assets in organized market (L15)	lowering of prices in organized market (D40)
OTC market expansion (L19)	increase in informational rents (D89)
increase in informational rents (D89)	inefficient allocation of talent (D29)