Working Paper: NBER ID: w28764
Authors: Ana Babus; Kinda Cheryl Hachem
Abstract: Regulatory debates about centralized trading assume security design is immune to market structure. We consider a regulator who introduces an exchange to increase liquidity, understanding that security design is endogenous. For a given security, investors would like to trade in a larger market and, for a given market structure, they would like to trade a safer security. We show that financial intermediaries design riskier securities after the exchange is introduced, even when the exchange leads to the origination of safer underlying assets. The results reflect a relative dilution of investor market power and motivate coordinated policies to improve investor welfare.
Keywords: No keywords provided
JEL Codes: D47; D86; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Introduction of centralized exchange (E42) | Increased market power of intermediaries (D40) |
| Increased market power of intermediaries (D40) | Riskier securities designed (G12) |
| Introduction of centralized exchange (E42) | Riskier securities designed (G12) |
| Dilution of investor market power (G19) | Riskier securities designed (G12) |
| Introduction of centralized exchange (E42) | Higher quality underlying assets originated (G19) |
| Higher quality underlying assets originated (G19) | Improved expected payoffs of securities (G19) |
| Loss of local market power of investors (G19) | Decline in security quality (L15) |