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An Information-Based Theory of Financial Intermediation

Zachary Bethune (), Bruno Sultanum () and Nicholas Trachter

No 19-12, Working Paper from Federal Reserve Bank of Richmond

Abstract: We advance a theory of how private information and heterogeneous screening ability across market participants shapes trade in decentralized asset markets. We solve for the equilibrium market structure and show that the investors who intermediate trade the most and interact with the largest set of counterparties must have the highest screening ability. That is, the primary intermediaries are those with superior information?screening experts. We provide empirical support for the model?s predictions using transaction-level micro data and information disclosure requirements. Finally, we study the connection between screening ability and efficiency, and observe that a market where all investors are screening experts?and thus, a market with no private information?may be dominated in terms of welfare by a market with no screening experts.

Keywords: Over-the-counter markets; intermediation; private information (search for similar items in EconPapers)
JEL-codes: D53 D82 G14 (search for similar items in EconPapers)
Pages: 71 pages
Date: 2019-07-02
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