Markets Versus Negotiations: The Emergence of Centralized Markets

Abstract

We study the incentives of privately informed traders who have access to two forms of trade: direct negotiations with a small number of buyers and sellers (or decentralized trade), and centralized markets with a relatively large number of buyers and sellers. We show that "weak" trader types (that is, buyers with a high willingness to pay and sellers with low costs) will prefer to trade through centralized markets. This leads to a complete unraveling of direct negotiations, so that ultimately, all "serious" buyers and sellers opt for trading through the centralized market. Once this happens, no trader can profitably trade through direct negotiations.

Keywords: centralized markets, decentralized markets, decentralized bargaining, market microstructure

JEL Classification: C78, D40, L10