Working Paper: NBER ID: w23234
Authors: Maryam Farboodi; Gregor Jarosch; Robert Shimer
Abstract: What market structure emerges when market participants can choose the rate at which they contact others? We show that traders who choose a higher contact rate emerge as intermediaries, earning profits by taking asset positions that are misaligned with their preferences. Some of them, middlemen, are in constant contact with other traders and so pass on their position immediately. As search costs vanish, traders still make dispersed investments and trade occurs in intermediation chains, so the economy does not converge to a centralized market. When search costs are a differentiable function of the contact rate, the endogenous distribution of contact rates has no mass points. When the function is weakly convex, faster traders are misaligned more frequently than slower traders. When the function is linear, the contact rate distribution has a Pareto tail with parameter 2 and middlemen emerge endogenously. These features arise not only in the (inefficient) equilibrium allocation, but also in the optimal allocation. Moreover, we show that intermediation is key to the emergence of the rest of the properties of this market structure.
Keywords: Market Structure; Intermediation; Contact Rates; Decentralized Markets
JEL Codes: E44; G12; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher contact rates (L96) | emergence as intermediaries (D40) |
| emergence as intermediaries (D40) | misaligned asset positions (G19) |
| higher contact rates (L96) | misaligned asset positions (G19) |
| contact rates (E43) | trading frequency (G14) |
| search costs vanish (D41) | trading in intermediation chains (L14) |
| distribution of contact rates (D39) | continuous distribution in equilibrium (D39) |
| Pareto distribution of contact rates (D39) | power law outcome in market structure (L11) |