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We experimentally analyze how to design preopening mechanisms facilitating coordination on high equilibrium liquidity and gains from trade. We allow a call auction to be preceded by a preopening or not, preopening orders to be binding or not, and the opening time to be deterministic or random. When the preopening is nonbinding, traders place manipulative orders, reducing the credibility of preplay communication. Random market opening deters manipulation, but also hinders communication by making it costly. Gains from trade are maximized when preopening orders are binding. This enables some traders to place early limit orders, attracting further liquidity. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1787. Keywords: cheap talk; experimental markets; equilibrium discovery; preopening period; preplay communication History: Received October 10, 2011; accepted May 22, 2013, by Wei Xiong, finance. Published online in Articles in Advance October 23, 2013., 1. Introduction At the opening of the market, there is large uncertainty about supply, demand, and valuations. Market openings can, therefore, be plagued by informational problems and coordination failures. Abstracting [...]

The competition between Island and Nasdaq at the beginning of the century offers a natural laboratory to study competition between and within trading platforms and its consequences for liquidity supply. Our empirical strategy takes advantage of the difference between the pricing grids used on Island and Nasdaq, as well as of the decline in the Nasdaq tick. Using the finer grid prevailing on their market, Island limit order traders undercut Nasdaq quotes, much more than they undercut one another. The drop in the Nasdaq tick size triggered a drop in Island spreads, despite the Island tick already being very thin before Nasdaq decimalization. We also estimate a structural model of liquidity supply and find that Island limit order traders earned rents before Nasdaq decimalization. Our results suggest that perfect competition cannot be taken for granted, even on transparent open limit order books with a very thin pricing grid. Key words: competition in financial markets; liquidity supply; trading mechanisms; different tick sizes History: Received December 4, 2008; accepted May 26, 2010, by Wei Xiong, finance., 1. Introduction Exchanges and trading mechanisms increasingly compete for orders. Regulators, such as the Securities and Exchange Commission (SEC) and the European Commission, have encouraged this competition. In the United [...]

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.3982/ECTA7261 Byline: Bruno Biais (*), Thomas Mariotti (**), Jean-Charles Rochet (***), Stephane Villeneuve ([dagger]) Keywords: Principal-agent model; limited liability; continuous time; Poisson risk; downsizing; investment; firm size dynamics Abstract: We study a continuous-time principal-agent model in which a risk-neutral agent with limited liability must exert unobservable effort to reduce the likelihood of large but relatively infrequent losses. Firm size can be decreased at no cost or increased subject to adjustment costs. In the optimal contract, investment takes place only if a long enough period of time elapses with no losses occurring. Then, if good performance continues, the agent is paid. As soon as a loss occurs, payments to the agent are suspended, and so is investment if further losses occur. Accumulated bad performance leads to downsizing. We derive explicit formulae for the dynamics of firm size and its asymptotic growth rate, and we provide conditions under which firm size eventually goes to zero or grows without bounds. Author Affiliation: (*)Toulouse School of Economics (CNRS, GREMAQ, IDEI), Universite Toulouse 1, 21 Allee de Brienne, 31000 Toulouse, France;biais@cict.fr (**)Toulouse School of Economics (CNRS, GREMAQ, IDEI), Universite Toulouse 1, 21 Allee de Brienne, 31000 Toulouse, France;mariotti@cict.fr (***)Toulouse School of Economics (GREMAQ, IDEI), Universite Toulouse 1, 21 Allee de Brienne, 31000 Toulouse, France;rochet@cict.fr ([dagger])Toulouse School of Economics (CRM, IDEI), Universite Toulouse 1, 21 Allee de Brienne, 31000 Toulouse, France;stephane.villeneuve@univ-tlse1.fr Article History: Manuscript received July, 2007; final revision received September, 2009.

Once they have observed information, hindsight-biased agents fail to remember how ignorant they were initially; "they knew it all along." We formulate a theoretical model of this bias, providing a foundation for empirical measures and implying that hindsight-biased agents learning about volatility will underestimate it. In an experiment involving 66 students from Mannheim University, we find that hindsight bias reduces volatility estimates. In another experiment, involving 85 investment bankers in London and Frankfurt, we find that more biased agents have lower performance. These findings are robust to differences in location, information, overconfidence, and experience. Key words: decision analysis; forecasting; finance; hindsight bias History: Received July 24, 2007; accepted December 23, 2008, by George Wu, decision analysis. Published online in Articles in Advance April 23, 2009., 1. Introduction Psychologists have extensively documented the prevalence of cognitive biases and deviations from rational choice. Are these results relevant for actual financial markets? Professionals, operating in their natural habitat [...]

We study how early-stage new ideas are turned into successful businesses. Even promising ideas can be unprofitable if they fail on one dimension, such as technical feasibility, correspondence to market [...]

We analyze politically motivated privatization in a bipartisan environment. When median-class voters a priori favor redistributive policies, a strategic privatization program allocating them enough shares can induce a voting shift away from left-wing parties whose policy would reduce the value of shareholdings. To induce median-class voters to buy enough shares to shift political preferences, strategic rationing and underpricing is often necessary. In the extreme, this may lead to free share distribution and voucher privatization. Shifting voting preferences becomes impossible when strong ex ante political constraints require large upfront transfers to insiders or when social inequality is extreme. (JEL D72, L33, P16, P35)

Consider strategic risk-neutral traders competing in schedules to supply liquidity to a risk-averse agent who is privately informed about the value of the asset and his hedging needs. Imperfect competition in this common value environment is analyzed as a multiprincipal game in which liquidity suppliers offer trading mechanisms in a decentralized way. Each liquidity supplier behaves as a monopolist facing a residual demand curve resulting from the maximizing behavior of the informed agent and the trading mechanisms offered by his competitors. There exists a unique equilibrium in convex schedules. It is symmetric and differentiable and exhibits typical features of market-power: Equilibrium trading volume is lower than ex ante efficiency would require. Liquidity suppliers charge positive mark-ups and make positive expected profits, but these profits decrease with the number of competitors. In the limit, as this number goes to infinity, ask (resp. bid) prices converge towards the upper (resp. lower) tail expectations obtained in Glosten (1994) and expected profits are zero. Keywords: Multi-principals, mechanism design, competing market-makers, financial markets microstructure.

As a centralized, computerized, limit order market, the Paris Bourse is particularly appropriate for studying the interaction between the order book and order flow. Descriptive methods capture the richness of the data and distinctive aspects of the market structure. Order flow is concentrated near the quote, while the depth of the book is somewhat larger at nearby valuations. We analyze the supply and demand of liquidity. For example, thin books elicit orders and thick books result in trades. To gain price and time priority, investors quickly place orders within the quotes when the depth at the quotes or the spread is large. Consistent with information effects, downward (upward) shifts in both bid and ask quotes occur after large sales (purchases). (Reprinted by permission of the publisher.)

This paper compares centralized and fragmented markets, such as floor and telephone markets. Risk-averse agents compete for one market order. In centralized markets, these agents are market order or limit order traders. They are assumed to observe the quotes of their competitors. In fragmented markets they are dealers. They can only assess the positions of their competitors. We analyze differences in bidding strategies reflecting differences in market structures. The equilibrium number of dealers is shown to be increasing in the frequency of trades and the volatility of the value of the asset. The expected spread is shown to be equal in both markets, ceteris paribus. But the spread is more volatile in centralized than in fragmented markets. (Reprinted by permission of the publisher.)

We analyze the optimal financing of investment projects when managers must exert unobservable effort and can also switch to less profitable riskier ventures. Optimal financing contracts can be implemented by a combination of debt and equity when the risk-shifting problem is the most severe while stock options are also needed when the effort problem is the most severe. Worsening of the moral hazard problems leads to decreases in investment and output at the macroeconomic level. Moreover, aggregate leverage decreases with the risk-shifting problem and increases with the effort problem. (Reprinted by permission of the publisher.)

An informed financial institution can trade on private information and also sell it to clients through a managed fund. To provide an incentive for the informed agent to trade in the interest of her client, the optimal contract requires that she be compensated as an increasing function of the profits of the fund. The optimal contract is also designed to limit the aggressiveness of the sum of the fund's trade and the proprietary trade. This reduces information revelation and thus leads to greater overall trading profits than if the informed agent only conducted proprietary trades. [ABSTRACT FROM AUTHOR]