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Markets vs. Mechanisms

Raphael Boleslavsky, Christoper Hennessy and David Kelly ()
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Raphael Boleslavsky: University of Miami
Christoper Hennessy: London School of Economics

No 2017-11, Working Papers from University of Miami, Department of Economics

Abstract: We demonstrate constraints on usage of direct revelation mechanisms (DRMs) by corporations inhabiting economies with securities markets. We consider a corporation seeking to acquire decision relevant information. Posting a standard DRM in an environment with a securities market endogenously increases the outside option of the informed agent. If the informed agent rejects said DRM, then she convinces the market that she is uninformed, and she can trade aggressively sans price impact, generating large (off-equilibrium) trading gains. Due to this endogenous outside option effect, using a DRM to screen out uninformed agents may be impossible. Even when screening is possible, refraining from posting a mechanism and instead relying on markets for information is optimal if the endogenous change in outside option value is sufficiently large. Finally, even if posting a DRM dominates relying on markets, outcomes are improved by introducing a search friction, which randomly limits the agent’s ability to observe the DRM, forcing the firm to sometimes rely on markets for information.

Keywords: Market Microstructure; Mechanism Design Publication Status: Submitted (search for similar items in EconPapers)
JEL-codes: G32 L14 D83 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-des, nep-mic and nep-ore
Date: 2017-09-28
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