Financial Expertise as an Arms Race

V. Glode, R.C. Green, R. Lowery

Research output: Working paperDiscussion paperOther research output

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Abstract

We propose a model in which rms involved in trading securities overinvest in financial expertise. Intermediaries or traders in the model meet and bargain over a financial asset. As in the bargaining model in Dang (2008), counterparties endogenously decide whether to acquire information, and improve their bargaining positions, even though the information creates adverse selection. We add to this setting the concept of "financial expertise" as resources invested to lower the cost of later acquiring information about the value of the asset being traded. These investments are made before the parties know about their role in the bargaining game, as proposer or responder, buyer or seller. A prisoner's dilemma arises because investments to lower information acquisition costs improve bargaining outcomes given the other party's information costs, even though the information has no social benefit. These investments lead to breakdowns in trade, or liquidity crises, in response to random but infrequent increases in asset volatility
Original languageEnglish
Place of PublicationTilburg
PublisherEBC
Number of pages55
Volume2010-22S
Publication statusPublished - 2010

Publication series

NameEBC Discussion Paper
Volume2010-22S

Fingerprint

Financial expertise
Arms race
Assets
Costs
Information costs
Liquidity crisis
Adverse selection
Traders
Breakdown
Resources
Bargaining model
Information acquisition
Bargaining games
Intermediaries
Financial assets
Social benefits
Prisoners' dilemma
Seller
Buyers

Keywords

  • Financial services
  • over-the-counter-markets
  • financial crises

Cite this

Glode, V., Green, R. C., & Lowery, R. (2010). Financial Expertise as an Arms Race. (EBC Discussion Paper; Vol. 2010-22S). Tilburg: EBC.
Glode, V. ; Green, R.C. ; Lowery, R. / Financial Expertise as an Arms Race. Tilburg : EBC, 2010. (EBC Discussion Paper).
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Glode, V, Green, RC & Lowery, R 2010 'Financial Expertise as an Arms Race' EBC Discussion Paper, vol. 2010-22S, EBC, Tilburg.

Financial Expertise as an Arms Race. / Glode, V.; Green, R.C.; Lowery, R.

Tilburg : EBC, 2010. (EBC Discussion Paper; Vol. 2010-22S).

Research output: Working paperDiscussion paperOther research output

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AB - We propose a model in which rms involved in trading securities overinvest in financial expertise. Intermediaries or traders in the model meet and bargain over a financial asset. As in the bargaining model in Dang (2008), counterparties endogenously decide whether to acquire information, and improve their bargaining positions, even though the information creates adverse selection. We add to this setting the concept of "financial expertise" as resources invested to lower the cost of later acquiring information about the value of the asset being traded. These investments are made before the parties know about their role in the bargaining game, as proposer or responder, buyer or seller. A prisoner's dilemma arises because investments to lower information acquisition costs improve bargaining outcomes given the other party's information costs, even though the information has no social benefit. These investments lead to breakdowns in trade, or liquidity crises, in response to random but infrequent increases in asset volatility

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Glode V, Green RC, Lowery R. Financial Expertise as an Arms Race. Tilburg: EBC. 2010. (EBC Discussion Paper).