Date of this Version
The Journal of Finance
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.
This is the peer reviewed version of the following article, which has been published in final form at http://dx.doi.org/10.1111/j.1540-6261.2012.01771.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.
Glode, V., Green, R. C., & Lowery, R. (2012). Financial Expertise as an Arms Race. The Journal of Finance, 67 (5), 1723-1759. http://dx.doi.org/10.1111/j.1540-6261.2012.01771.x
Date Posted: 27 November 2017
This document has been peer reviewed.