Regulation and Security Design in Concentrated Markets

Ana Babus and Kinda Hachem

No 15861, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: The vast majority of regulatory debates about the benefits of centralized trading assume that the set of securities designed by financial intermediaries is immune to the market structure in which trade occurs. In this paper, we consider a regulator who redesigns the market structure for certain financial contracts by introducing an exchange to increase liquidity, understanding that security design is endogenous. For a given market structure, investors would like to trade a less risky security and, for a given security, they would like to trade in a larger market. We show that the security that intermediaries design after the introduction of the exchange is of lower quality, in the sense of a lower expected payoff per unit of standard deviation. This reflects the relative dilution of investor market power, as investors have zero price impact on the exchange and hence less influence on intermediary security design. The issuance of lower quality securities to investors arises even when the introduction of the exchange leads intermediaries to originate better underlying assets. With a large enough exchange, the decline in the quality of the security is so severe that investors can be worse off as a result of the introduction of the exchange. We then consider how origination subsidies could be used by the regulator to counter the negative effects of introducing the exchange on security design.

Keywords: Security design; Market structure; market power (search for similar items in EconPapers)
JEL-codes: D47 D86 G23 (search for similar items in EconPapers)
Date: 2021-03
New Economics Papers: this item is included in nep-cwa
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Regulation and security design in concentrated markets (2021)
Working Paper: Regulation and Security Design in Concentrated Markets (2021)
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