Journal of Finance Vol. 67 No. 5 2012

Financial Expertise as an Arms Race

Vincent Glode^1,2; Richard C. Green³; Richard Lowery^4,5,3,2,6

¹ California University of Pennsylvania · ² University of Pennsylvania · ³ Carnegie Mellon University · ⁴ Springer Nature (Germany) · ⁵ Cornell University · ⁶ The University of Texas at Austin

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.

DOI

10.1111/j.1540-6261.2012.01771.x

Volume

67

Issue

5

Pages

1723-1759

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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