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Incomplete Markets and Incentives to Set Up an Options Exchange


Traditional analyses with incomplete markets take the securities that are traded as exogenous. In this paper we endogenize the market structure by considering incentives to introduce (costly) options exchanges which issue derivative securities. The method of financing the exchange is critical in determining whether the market structure is socially efficient. If the exchange can charge fees to all agents and make every agent's participation a necessary condition for establishing the exchange then the market structure chosen in equilibrium is efficient. However, if either of these conditions is not satisfied then an inefficient market structure may be chosen.

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We would like to thank the editor, Herakles Polemarchakis, and an anonymous referee for helpful comments and suggestions. Financial support from the NSF (Grant nos. SES-8813719 and SES-8720589 for the two authors respectively) is gratefully acknowledged.

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Allen, F., Gale, D. Incomplete Markets and Incentives to Set Up an Options Exchange. Geneva Risk Insur Rev 15, 17–46 (1990).

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