Transcript Market Microstructure and Intermediation

Market
Microstructure
and
Intermediation
Three Basic Questions

three basic questions in the classical
economics:
•
•
•
what shall be produced
how shall it be produced
for whom
The Fourth Question

Stiglitz(1994):
How should these decisions be made, and who
should make them?
Answer to the Fourth Question
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Firms decide what, how and for whom
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Firms create and manage markets
between buyers and sellers by acting as
intermediaries
What Is Intermediary? (I)
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An intermediary is an economic agent
that
•
purchases from suppliers for resale to buyers
suppliers
purchase
Interme
diary
resale
buyers
What Is Intermediary? (II)
•
or, helps sellers and buyers meet and transact
sellers
Interme
diary
buyers
What is Microstructure?


In finance, the study of intermediation
and the institutions of exchanged is
called market microstructure
we apply this term to markets in general
Why should the intermediation
be paid more attention to?

In the U.S. economy, they comprise over a
quarter of GDP
Intermediaries have these four
most important functions:
• setting prices and clearing markets
• providing liquidity and immediacy
• coordinating buyers and sellers in
•

matching and searching
guaranteeing quality and monitoring
performance
Our purpose is to develop these four
functions from now on.
Price Setting and Market
Clearing
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In a perfectly competitive market,
firms are only price-takers
Price Setting and Market
Clearing

In reality, many firms have some market
power to adjust prices, due to
• product differentiation, transportation costs,
consumer switching costs, transaction cost,
barriers to entry, incomplete price, and so on
Price Setting and Market
Clearing
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Consider an intermediary that has
market power in both its customer and
supplier markets

This intermediary thus has some power
to set both bid and ask prices
The Bid-Ask Spread and the
Supply and Demand Model
p, w
S(w)
p*
pw
w*
D(p)
Q*
Qw
Q
How the firm adjusts prices to
clear market?
p, w
S(w)
p*
pw
w*
D’(p)
D(p)
Q*
Qw
Q
Providing Liquidity and
Immediacy

The problem of double coincidence of
wants
commodities
•Supplier
•Customer
cash
Providing Liquidity and
Immediacy

How intermediaries provide liquidity
commodities
•Supplier
inventory
Intermediary
cash
money
•Customer
How Intermediaries adjust price to
maintain inventories and cash?
p, w
S(w)
p*
w*
D(p)
Q*
X
Q
Matching and Searching

Matching
• Without intermediaries: decentralized
exchange fashion, more risky option
• With intermediaries: centralized exchange
fashion, trade at a known price
Matching and Searching
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Searching
• Searching costs
• Transportation cost
• Communicating cost
• Time cost and discount rate
• Intermediaries can reduced those cost by
creating centralized exchange fashion
Guaranteeing and Monitoring

Asymmetric information
Guaranteeing and Monitoring:
Used Car Case
High-quality car
Low-quality car
$200
$100
Potential buyer 1
Potential buyer 2
$220
$130
Guaranteeing and Monitoring:
Used Car Case

Without intermediaries, buyer 1 will pay
$150
High-quality car
Low-quality car
quit
$150
Potential buyer 1
Potential buyer 2
Pay $150($-50)
quit
Guaranteeing and Monitoring:
Used Car Case

With intermediaries,
High-quality car
Low-quality car
$200
$100
intermediaries
directly
Potential buyer 1
Potential buyer 2
$220
$130
Guaranteeing and Monitoring

Delegated Monitoring
• Example: financial intermediation
Conclusion

Intermediaries provide the underlying
microstructure of most markets.
Our Question

1. How will an intermediary adjust its bidask price when the demand it faces shift
up? (Suppose this intermediary has
market power to set prices on both sides)
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2. What’s the transaction in the used car
case with and without intermediary?
Our Group Member
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
Chen Binglin
Chen Guojun
Gao Jin
Pan Xuejia
Yang Han
Thank You!

Any questions or comments are
welcome!