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Endogenous market making and network formation

Chang, Briana and Zhang, Shengxing (2015) Endogenous market making and network formation. SRC Discussion Paper (No 50). Systemic Risk Centre, The London School of Economics and Political Science, London, UK.

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Abstract

This paper proposes a theory of intermediation in which intermediaries emerge endogenously as the choice of agents. In contrast to the previous trading models based on random matching or exogenous networks, we allow traders to explicitly choose their trading partners as well as the number of trading links in a dynamic framework. We show that traders with higher trading needs optimally choose to match with traders with lower needs for trade, and they build fewer links in equilibrium. As a result, traders with the least trading need turn out to be the most connected and have the highest gross trade volume. The model therefore endogenously generates a core-periphery trading network that we often observe: a financial architecture that involves a small number of large, interconnected institutions. We use this framework to study bid-ask spreads, trading volume, asset allocation.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.systemicrisk.ac.uk/
Additional Information: © 2015 The Authors
Divisions: Economics
Systemic Risk Centre
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HG Finance
JEL classification: C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C70 - General
G - Financial Economics > G1 - General Financial Markets
G - Financial Economics > G2 - Financial Institutions and Services > G20 - General
Sets: Departments > Economics
Research centres and groups > Systemic Risk Centre
Date Deposited: 21 Jan 2016 16:28
Last Modified: 14 Mar 2019 00:04
Projects: ES/K002309/1
Funders: ESRC
URI: http://eprints.lse.ac.uk/id/eprint/65105

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