This paper models the specialist system as a monopolistically competitive market. Demand for the asset is found by solving the investor's portfolio problem with transactions costs. These demand equations are used as inputs in the specialist's price-setting problem. Equilibrium prices and, hence, equilibrium portfolio holdings depend upon the characteristics of the assets and the investors and the number of assets being traded. Conditions are given under which the bid and ask prices will converge to the competitive level as the number of assets increases. Predictive differences between a monopolistically competitive market and a market where specialists collude are also discussed.

Journal Article Derivatives: A PowerPlus Picture Book Get access Derivatives: A PowerPlus Picture Book. Mark Rubinstein. Kathleen Hagerty Kathleen Hagerty Northwestern University Search for other works by this author on: Oxford Academic Google Scholar The Review of Financial Studies, Volume 13, Issue 1, January 2000, Pages 253–256, https://doi.org/10.1093/rfs/13.1.253 Published: 15 June 2015

[Financial market regulations require various "insiders" to disclose their trades after the trades are made. We show that such mandatory disclosure rules can increase insiders' expected trading profits. This is because disclosure leads to profitable trading opportunities for insiders even if they possess no private information on the asset's value. We also show that insiders will generally not voluntarily disclose their trades, so for disclosure to be forthcoming, it must be mandatory. Key to the analysis is that the market cannot observe whether an insider is trading on private information regarding asset value or is trading for personal portfolio reasons.]

Kathleen M. Hagerty, Daniel R. Siegel; On the Observational Equivalence of Managerial Contracts Under Conditions of Moral Hazard and Self-Selection*, The Q

Financial market regulations require various “insiders” to disclose their trades after the trades are made. We show that such mandatory disclosure rules can increase insiders’ expected trading profits. This is because disclosure leads to profitable trading opportunities for insiders even if they possess no private information on the asset’s value. We also show that insiders will generally not voluntarily disclose their trades, so for disclosure to be forthcoming, it must be mandatory. Key to the analysis is that the market cannot observe whether an insider is trading on private information regarding asset value or is trading for personal portfolio reasons.

In this paper a party with private information can verifiably disclose some, but not all, of his information. The optimal amount of discretion to allow the informed party is studied. That is, should the informed party be allowed unlimited discretion in choosing which elements of his information set to disclose, or should restrictions be imposed that limit this discretion? The model is formulated in the spirit of a “persuasion game.” It is demonstrated that under certain circumstances, rules that limit discretion increase the informativeness of disclosures and thus improve economic decisions.

This paper develops a model of the relationship between investment decisions by firms and the efficiency of the market prices of their securities. It is shown that more efficient security prices can lead to more efficient investment decisions. This provides firms with the incentive to increase price efficiency by voluntarily disclosing information about the firm. Disclosure decisions are studied. It is shown that firms may expend more resources on disclosure than is socially optimal. This is in contrast to the concern implicit in mandatory disclosure rules that firms will expend too few resources on disclosure.

Self-regulation is a feature of a number of professions. For example, in the U.S. the government delegates aspects of financial market regulation to self-regulatory organizations (SROs) like the New York Stock Exchange and the National Association of Securities Dealers. We analyse one regulatory task of an SRO, enforcing antifraud rules so agents will not cheat customers. Specifically, we model contracting/enforcement as a two-tier problem. An SRO chooses its enforcement policy: the likelihood that an agent is investigated for fraud and a penalty schedule. Given an enforcement policy, agents compete by offering contracts that maximize customers' expected utility. We assume that the SRO's objective is to maximize the welfare of its members, the agents. We show that the SRO chooses a more lax enforcement policy—meaning less frequent investigations—than what customers would choose. A general conclusion is that control of the enforcement policy governing contracts confers substantial market power to a group of otherwise competitive agents. We also investigate government oversight of the self-regulatory process. The threat of government enforcement leads to more enforcement by the SRO, just enough to pre-empt any government enforcement.

Regulating insider trading lessens the adverse selection problem facing market makers, enabling them to quote better prices. An Optimal enforcement policy must balance these benefits against the costs of enforcement. Such a policy must specify (i) the conditions under which the regulator conducts an investigation, (ii) the penalty schedule imposed if an insider is caught, and (iii) a transaction tax to fund enforcement. We derive the policy that maximizes investors welfare. This policy entails investigations following large trading volumes or large price movements or both. Insiders caught making large trades are assessed the maximum penalty, but small trades are not penalized. Given this policy, insiders trade most aggressively on news with an intermediate price impact but refrain from trading on moderate or extreme news.