George R. Hall, Asymmetry of Information, Regulatory Lags and Optimal Incentive Contracts: Theory and Evidence: Discussion, The Journal of Finance, Vol. 38, No. 2, Papers and Proceedings Forty-First Annual Meeting American Finance Association New York, N.Y. December 28-30, 1982 (May, 1983), pp. 431-432

We present a model in which the microstructure of trade in a commodity or asset is endogenously determined. Producers and consumers of a commodity (or buyers and sellers of an asset) who wish to trade can choose between two competing types of intermediaries: “middlemen” (dealer/brokers) and “market makers” (specialists). Market makers post publicly observable bid and ask prices, whereas the prices quoted by different middlemen are private information that can be obtained only through a costly search process. We consider an initial equilibrium with which there are no market makers but there is free entry of middlemen with heterogeneous transactions costs. We characterize conditions under which entry of a single market maker can be profitable even though it is common knowledge that all surviving middlemen will undercut the market maker’s publicly posted bid and ask prices in the postentry equilibrium. The market maker’s entry induces the surviving middlemen to reduce their bid‐ask spreads, and as a result, all producers and consumers who choose to participate in the market enjoy a strict increase in their expected gains from trade. When there is free entry into market making and search and transactions costs tend to zero, bid‐ask spreads of all market makers and middlemen are forced to zero, and a fully efficient Walrasian equilibrium outcome emerges.

From a new data set, we infer time series of term structures of yields on U.S. federal bonds during the gold standard era from 1791–1933 and use our estimates to reassess historical narratives about how the United States expanded its fiscal capacity. We show that U.S. debt carried a default risk premium until the end of the nineteenth century, when it started being priced as an alternative safe asset to U.K. debt. During the Civil War, investors expected the United States to return to a gold standard so the federal government was able to borrow without facing denomination risk. After the introduction of the National Banking System, the slope of the yield curve switched from down to up and the premium on U.S. debt with maturity less than one year disappeared.