Financial Expertise as an Arms Race

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

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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

Keywords

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

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  • Cite this

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