Price Competition Between Market Makers

The paper models explicitly the price competition in financial markets, where prices are quoted by competing dealers (market makers) before future demand is observed. In markets with adverse selection, the strategic behaviour of informed insiders and uninformed liquidity traders implies, that a growing number of market makers induces a higher risk exposure of the individual market marker. It is shown, that this leads both to higher individual bid-ask-spreads and to a higher market spread as competition becomes more intense. Conditions are derived, under which the market would prefer a monopolistic market rather than several competing market makers. 

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