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Augmenting Markets with Mechanisms

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We model a market in which traders lay off their excess inventories of an asset in a sequence of size-discovery sessions and on a continuously operating exchange. Taking the exchange as given; we derive a size-discovery mechanism that efficiently reallocates the asset across traders at each session. Between sessions, in a dynamic exchange double-auction market, traders strategically lower their price impacts by shading their bids, causing socially costly delays in re-balancing the asset across traders. As the expected frequency of size-discovery sessions is increased, exchange market depth is further lowered, offsetting the efficiency gains of the size-discovery sessions. Adding size-discovery sessions to the exchange market has no social value, beyond that of a potential initialiSing session. If, as in practice, size-discovery sessions rely on price information from the exchange to set the terms of trade, then bidding incentives are further weakened, strictly reducing overall market efficiency.

This talk is part of the Finance Seminars, CJBS series.

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