I analyze a market with large and small traders with different values. I show that illiquidity and information efficiency are complements. Policy measures promoting liquidity might be harmful for information efficiency and vice versa. An increase in risk-bearing capacity may harm liquidity. An increase in the precision of information may harm information efficiency. Increasing market power or breaking up a centralized market into two separate exchanges might improve welfare. Multiple equilibria, in which higher liquidity is associated with lower information efficiency, are possible. Applied to crude oil market the model highlights (1) informational frictions and (2) market power of producers amplified by (1) as possible drivers of recent sharp price changes.
Author:
Sergei GLEBKIN (INSEAD)
Discussant:
David Brown (University of Arizona)