Optimal Liquidity Provision for Decision Makers
Coauthor(s): Robert Hahn.
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Although prices in financial markets play an important role in improving allocative efficiency in the real economy, few models of securities markets explicitly incorporate resource allocation decisions. In this paper, we study the equilibrium in a securities
market when the market price provides valuable information that can improve allocative efficiency. We show that a decision maker will subsidize liquidity in an illiquid securities market to gather valuable information about her decision payoffs. We also show that a decision maker's liquidity subsidy improves expected social welfare by enhancing allocative efficiency, but does not induce the socially optimal level of information acquisition. Finally, we demonstrate that the mere act of linking the allocation decision to the market price will typically enhance liquidity in the securities market.
Overall, our results highlight the potential of using securities markets for information to improve public and private decisions.
Source: Working Paper
Hahn, Robert, and Paul Tetlock. "Optimal Liquidity Provision for Decision Makers." Working Paper, Columbia Business School, 2007.