Financial expertise as an arms race

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

Research output: Contribution to journalArticleScientificpeer-review

Abstract

We show that firms intermediating trade have incentives to overinvest in financial expertise. In our model, expertise improves firms’ ability to estimate value when trading a security. Expertise creates asymmetric information, which, under normal circumstances, works to the advantage of the expert as it deters opportunistic bargaining by counterparties. This advantage is neutralized in equilibrium, however, by offsetting investments by competitors. Moreover, when volatility rises the adverse selection created by expertise triggers breakdowns in liquidity, destroying gains to trade and thus the benefits that firms hope to gain through high levels of expertise.
Original languageEnglish
Pages (from-to)1723-1759
JournalJournal of Finance
Volume67
Issue number5
Publication statusPublished - 2012

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Financial expertise
Arms race
Expertise
Adverse selection
Breakdown
Asymmetric information
Competitors
Liquidity
Incentives
Trigger

Cite this

Glode, V., Green, R. C., & Lowery, R. (2012). Financial expertise as an arms race. Journal of Finance, 67(5), 1723-1759.
Glode, V. ; Green, R.C. ; Lowery, R. / Financial expertise as an arms race. In: Journal of Finance. 2012 ; Vol. 67, No. 5. pp. 1723-1759.
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Glode, V, Green, RC & Lowery, R 2012, 'Financial expertise as an arms race', Journal of Finance, vol. 67, no. 5, pp. 1723-1759.

Financial expertise as an arms race. / Glode, V.; Green, R.C.; Lowery, R.

In: Journal of Finance, Vol. 67, No. 5, 2012, p. 1723-1759.

Research output: Contribution to journalArticleScientificpeer-review

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T1 - Financial expertise as an arms race

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AU - Green, R.C.

AU - Lowery, R.

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N2 - We show that firms intermediating trade have incentives to overinvest in financial expertise. In our model, expertise improves firms’ ability to estimate value when trading a security. Expertise creates asymmetric information, which, under normal circumstances, works to the advantage of the expert as it deters opportunistic bargaining by counterparties. This advantage is neutralized in equilibrium, however, by offsetting investments by competitors. Moreover, when volatility rises the adverse selection created by expertise triggers breakdowns in liquidity, destroying gains to trade and thus the benefits that firms hope to gain through high levels of expertise.

AB - We show that firms intermediating trade have incentives to overinvest in financial expertise. In our model, expertise improves firms’ ability to estimate value when trading a security. Expertise creates asymmetric information, which, under normal circumstances, works to the advantage of the expert as it deters opportunistic bargaining by counterparties. This advantage is neutralized in equilibrium, however, by offsetting investments by competitors. Moreover, when volatility rises the adverse selection created by expertise triggers breakdowns in liquidity, destroying gains to trade and thus the benefits that firms hope to gain through high levels of expertise.

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JF - The Journal of Finance

SN - 0022-1082

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Glode V, Green RC, Lowery R. Financial expertise as an arms race. Journal of Finance. 2012;67(5):1723-1759.