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Information and Competition

Final Report Summary - INFOCOMP (Information and Competition)

The general aim of the project has been to advance our knowledge of the functioning of markets when traders and firms have private information about payoff relevant parameters. The welfare analysis of economies with dispersed information has proved challenging. The project has made progress removing important stumbling blocks: lack of understanding of the interaction between payoff and informational externalities, including the dynamics in markets with complementarities and information; consideration of public information as exogenous; and avoidance or extreme simplification of welfare analysis (e.g. because of the lack of a well-defined welfare benchmark and/or the presence of exogenous noise traders in the model). The results obtained have a wide application to the design of markets (such as Treasury or liquidity auctions), the understanding of trading and price dynamics in financial markets (explaining departures from informational efficiency and prices that depart from fundamental values), and the identification of the mechanisms of financial crises and the role of prudential measures, such as capital and liquidity requirements, that may prevent them or alleviate their effects.

In relation to market design the results may help explain pricing patterns arising in electricity markets, revenue management, and auctions. For example, ignoring private cost information with supply function competition in electricity markets may underestimate the slope of supply; and the Treasury may overpay in reverse auctions for toxic assets due to increased correlation of valuations for the bidding banks in a crisis situation, which makes the demand schedules of the bidders steeper. With regard to policy, it is shown how in a financial crisis, loosening collateral requirements may be part of an optimal subsidy scheme to banks, or how a subsidy to bidders may be explained in the US Public-Private Investment Program of March 2009 scheme for legacy loans auctions. In regard to regulation of financial intermediaries the results show how capital and liquidity requirements have to be set together and coordinated with disclosure requirements in order to contain crises.
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