Tough Middlemen

Guido Menzio, Gregor Jarosch and Maryam Farboodi
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Gregor Jarosch: Stanford University
Maryam Farboodi: Princeton University

No 1371, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We study a decentralized asset market in the spirit of Duffie, Petersen and Garleanu (2005). Agents are heterogeneous with respect to their valuation of the asset, and with respect to their bargaining ability. Specifically, a tough agent can make a take-it-or-leave it offer to soft agents and (with probability 1/2) to another tough agent. A soft agent makes (with probability 1/2) a take-it-or-leave-it offer to another soft-agent. In this environment, we show that tough agents become intermediaries, in the sense that a tough agent buys and sells the asset from a soft agent even when the two have the same valuation. We show that, in the presence of transaction costs, the non-fundamental trades carried out by tough agents are socially inefficient. We then show that, if tough agents cannot distinguish the identity of their trading partners, then intermediaries do not trade with each other even when they have different valuations. The unexecuted fundamental trades between tough agents are a second source of inefficiency. Finally, we show that—if agents can choose whether to pay a cost to become tough—the equilibrium involves mixing: a positive measure of agents is soft and a positive measure of agents is tough.

Date: 2016
New Economics Papers: this item is included in nep-mic
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