Moral Hazard and Imperfect Competition in Financial Markets
Research Seminars: Virtual Market Design SeminarWhen financial intermediaries invest on behalf of clients, they exert effort that clients cannot contract on and compete when trading assets. The paper presented in this Virtual Market Design Seminar develops a model in which the resulting moral hazard and degree of competition interact through market clearing, so that the incentive contracts clients offer intermediaries depend on how many intermediaries compete. The author shows that greater competition can tighten incentive constraints and reduce welfare. Pricing patterns in proprietary Canadian equity data are consistent with both frictions, and, read through the lens of the model, suggest a welfare loss from greater competition. This calls for coordinating competition and conduct regulation.
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