Equilibrium bid-ask spreads and the effect of competitive trading delays

Elisa Luciano and Antonella Tolomeo

No 467, Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: The paper studies the equilibrium bid-ask spread and time-to-trade in a continuous-time, intermediated financial market. Market makers are monopolists, but random switches to a disintermediated market - interpreted as an option to wait and trade without bid-ask spread - occur. In equilibrium, this lowers spreads dramatically and generates higher fees for smaller investors, especially if their risk aversion is close to the market maker's one. Capital constraints on intermediaries easily lead to a second best. We analyze the effects of policy interventions in favour of disintermediation and deterring speculation on the part of market makers. We conclude for a positive effect of the Volcker rule on costs and liquidity.

Keywords: equilibrium with transaction costs; equilibrium with inter mediaries; infrequent trading; trading delays; endogenous bid-ask spread; OTC markets. (search for similar items in EconPapers)
JEL-codes: G11 G12 (search for similar items in EconPapers)
Pages: pages 53
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:cca:wpaper:467

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