ABSTRACT 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 makers 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.

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 a re market makers or limit order traders. They are assumed to observe th e quotes of their competitors. In fragmented markets they are dealers. They can only assess the positions of their competitors. The author analyzes 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 valu e of the asset: The expected spread is shown to be equal in both marke ts, ceteris paribus. But the spread is more volatile in centralized than in fragmented markets.

We study opening prices set simultaneously for German and French stocks in Frankfurt and Paris. In our model investors and traders based in the same country as the firm have better information on its value than foreign traders. Our theory implies that prices set on the domestic market differ from (and are more informationally efficient than) prices set on the foreign market. Empirically, we find significant price discrepancies between home and foreign prices, consistent with lack of integration of international financial markets. For German stocks, home prices are found to be informationally more efficient than foreign prices. The informational efficiency of French stock prices is comparable in the two markets when Frankfurt traders can observe Paris preopening prices before the opening.

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.

[Asymmetric information between banks and firms can preclude financing of valuable projects. Trade credit can alleviate this problem by incorporating in the lending relation the private information held by suppliers about their customers. Incentive compatibility conditions prevent collusion between two of the agents (e.g., the buyer and the seller) against the third (e.g., the bank). Consistent with the empirical findings of Petersen and Rajan (1995), firms without relationships with banks resort more to trade credit, and sellers with greater ability to generate cash flows provide more trade credit. Finally small firms react to monetary contractions by using trade credit, consistent with the empirical results of Nilsen (1994).]

We analyze the introduction of a nonredundant option, which completes the markets, and the effects of this on information revelation and risk sharing. The option alters the interaction between liquidity and insider trading. We find that the option mitigates the market breakdown problem created by the combination of market incompleteness and asymmetric information. The introduction of the option has ambiguous consequences on the informational efficiency of the market. On the one hand, by avoiding market breakdown, it enables trades to occur and convey information. On the other hand, the introduction of the option enlarges the set of trading strategies the insider can follow. This can make it more difficult for the market makers to interpret the information content of trades and consequently can reduce the informational efficiency of the market. The introduction of the option also has an ambiguous effect on the profitability of insider trades, which can either increase or decrease depending on parameter values.

[We analyze the introduction of a nonredundant option, which completes the markets, and the effects of this on information revelation and risk sharing. The option alters the interaction between liquidity and insider trading. We find that the option mitigates the market breakdown problem created by the combination of market incompleteness and asymmetric information. The introduction of the option has ambiguous consequences on the informational efficiency of the market. On the one hand, by avoiding market breakdown, it enables trades to occur and convey information. On the other hand, the introduction of the option enlarges the set of trading strategies the insider can follow. This can make it more difficult for the market makers to interpret the information content of trades and consequently can reduce the informational efficiency of the market. The introduction of the option also has an ambiguous effect on the profitability of insider trades, which can either increase or decrease depending on parameter values.]

Unseasoned shares are sold through the Book Building process in the United States and the United Kingdom, fixed price offerings in several countries, uniform price auctions in Israel or the new internet-based Open IPO mechanism, and an auction-like mechanism called the Mise en Vente in France. We analyze and compare the performance of these various IPO mechanisms within the context of a unified theoretical model. Fixed price offerings lead to inefficient pricing and winner's curse. Dutch auctions can also lead to inefficiencies, to the extent that they are conducive to tacit collusion by investors. The Book Building and Mise en Vente can lead to optimal information elicitation and price discovery. We document empirically the similarity between the Book Building and the Mise en Vente. We discuss the implications of our analysis for the design of optimal Internet IPO auctions. Journal of Economic Literature Classification Numbers: G24, G3, D82.

We analyze the optimal financing of investment projects when managers must exert unobservable effort and can also switch to less profitable riskier ventures. Optimal financial 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.