Regulation and security design in concentrated markets

Regulatory debates about centralized trading assume security design is immune to market structure. We consider a regulator who introduces an exchange to increase liquidity, understanding that security design is endogenous. For a given security, investors would like to trade in a larger market and, for a given market structure, they would like to trade a safer security. We show that financial intermediaries design riskier securities after the exchange is introduced, even when the exchange leads to the origination of safer underlying assets. The results reflect a relative dilution of investor market power and motivate coordinated policies to improve investor welfare. (c) 2021 Elsevier B.V. All rights reserved.

Automated summary

The study demonstrates that financial intermediaries design riskier securities after the introduction of an exchange, even with safer underlying assets. The results indicate a relative dilution of investor market power, highlighting the need for coordinated policies to improve investor welfare.