Publications, published discussions and reviews:
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Abstract: We study the design of enforcement mechanisms when enforcement resources are chosen ex ante and are inelastic ex post. Multiple equilibria arise naturally. We identify a new answer to the old question of why non-maximal penalties are used to punish moderate actions: "marginal" penalties are muchmore attractive in the Pareto inferior crime wave equilibrium. Specifically, although marginal penalties have both costs and benefits, the net benefit is strictly positive in the crime wave equilibrium. In contrast, marginal penalties frequently have a net cost in the non-crime wave equilibrium. We also show that increasing enforcement resources may worsen crime.
Abstract: 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.
Mandatory versus Voluntary Disclosure in Markets with Informed and Uninformed Customers
Abstract: Numerous rules mandate the disclosure of sellers' information. This article analyzes two questions regarding disclosure: (i) Why wouldn't sellers voluntarily disclose their information? and (ii) Who gains and who loses with mandatory disclosure? Previous analyses assume that all customers are knowledgeable enough to understand a seller's disclosure, and a key result is that there is no role for mandatory disclosure. Either voluntary disclosure is forthcoming, or if it is not, no one prefers mandatory disclosure. We generalize the standard model by considering the case in which not all customers understand a seller's disclosure. We show that if the fraction of customers who can understand a disclosure is too low, voluntary disclosure may not be forthcoming. If so, mandatory disclosure benefits informed customers, is neutral for uninformed customers, and harms the seller. Our results suggest that we should find mandatory disclosure in markets where product information is relatively difficult to understand.Review of "Derivatives: A PowerPlus Picture Book
Review of Financial Studies, Summer 2000, 13(1): 253-256
Review of "Investment Intelligence from Insider Trading"
The Optimal Enforcement of Insider Trading Regulations
Abstract: Regulating insider trading lessens the adverse selection problem, enabling marketmakers to quote better prices. Optimal enforcement balances these benefits against enforcement costs. An enforcement policy specifies the time at which the regulator conducts an investigation, the penalty if an insider is caught, and a transaction tax to fund enforcement. The policy that maximizes investors' welfare entails investigations following large trading volumes or price movements. Insiders caught making large trades pay the maximum penalty but small trades are not penalized. Given this policy, insiders trade aggressively on news with an intermediate price impact but refrain from trading on moderate or extreme news.Brokerage, Market Fragmentation, and Securities Market Regulation
(with Robert McDonald)
Lo, Andrew W., ed. (1996). The industrial organization and regulation of securities industry. National Bureau of Economic Research Conference Report series. Chicago and London: University of Chicago Press, pp. 35-56
Brokerage, Market Fragmentation, and Securities Market Regulation: Reply
The Mandatory Disclosure of Trades and Market Liquidity
Abstract: 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.The Incentive to Sell Financial Market Information
(with Michael Fishman)
Journal of Financial Intermediation, April 1995, 4(2): 95-115
Abstract: Investment advisory firms and brokerage firms hire analysts to uncover profitable securities investment opportunities. Then these firms sell the information (either directly or indirectly) to others. Why? Given that the information has value, why do these firms not keep the information to themselves and trade solely for their own accounts? Because of competition, information is more valuable when fewer people trade on the information. This paper shows that selling information is a strategic response by competing informed traders. Specifically, it is a means for informed traders to commit to trade aggressively, thereby inducing other informed traders to trade less aggressively. (c) 1995 Academic Press, Inc.Insider Trading and the Efficiency of Stock Prices
(with Michael Fishman)
RAND Journal of Economics, Spring 1992, 23(1): 106-22
Abstract: The authors analyze several aspects of the debate on insider trading regulations. Critics of such regulations cite various benefits of insider trading. One prominent argument is that insider trading leads to more informationally efficient stock prices. They show that under the circumstances, insider trading leads to less efficient stock prices. This is because insider trading has two adverse effects on the competitiveness of the market: it deters other traders from acquiring information and trading, and it skews the distribution of information held by traders toward one trader. They also discuss whether shareholders of a firm have the incentives to restrict insider trading on their own.Equilibrium Bid-Ask Spreads in Markets with Multiple Assets
Review of Economic Studies, April 1991, 58(2): 237-57
Abstract: 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.The Optimal Amount of Discretion to Allow in Disclosure
(with Michael Fishman)
Quarterly Journal of Economics, May 1990, 105(2): 427-44
Abstract: 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.Disclosure Decisions by Firms and the Competition for Price Efficiency
(with Michael Fishman)
Journal of Finance, July 1989, 44(3): 633-46
Reprinted in Brennan, Michael (ed). The theory of corporate finance, Volume 2. Elgar Reference Collection. Cheltenham, U.K.: Elgar, 1996, pp. 255-68.
Abstract: 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.On the Observational Equivalence of Managerial Contracts under Conditions of Moral Hazard and Self-selection
(with Daniel Siegel)
Quarterly Journal of Economics, May 1988, 103(2): 425-28
Abstract: Managerial contracts often tie compensation to the performance of the firm. Two models of contracting under asymmetric information, moral hazard and self-selection, are used to explain this phenomenon. An important direction for research in this area will be to use data on managerial contracts to sharpen our understanding of the settings in which a given informational problem is most important. The purpose of this paper is to ask whether this is possible using static models of contracting under asymmetric information. To address this question, we compare the standard principal-agent model presented by Grossman and Hart  with a plausible self-selection model, where the firm only wants to hire a manager with a particular level of productivity. We call this self-selection model a talent search.Robust Trading Mechanisms
(with William Rogerson)
Journal of Economic Theory, June 1987, 42(1): 94-107
Abstract: This paper considers the problem of designing a trading institution for a single buyer and seller when their valuation of the good is private information. It is shown that posted-price mechanisms are essentially the only mechanisms such that each trader has a dominant strategy. A posted-price mechanism is one where a price is posted in advance and trade occurs if, and only if, all traders agree to trade.Dealerships, Trading Externalities, and General Equilibrium
(with Sudipto Bhattacharya)
Prescott, Edward C., and Neil Wallace (eds). Contractual arrangements for intertemporal trade. Minnesota Studies in Macroeconomics series, vol. 1. Minneapolis: University of Minnesota Press 1987, pp. 81-104