Finance Papers

Document Type

Journal Article

Date of this Version

2012

Publication Source

The Journal of Finance

Volume

67

Issue

5

Start Page

1723

Last Page

1759

DOI

10.1111/j.1540-6261.2012.01771.x

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.

Copyright/Permission Statement

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.

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Date Posted: 27 November 2017

This document has been peer reviewed.