Innovation in Decentralized Markets

In today’s markets, thousands of financial assets are traded in a variety of coexisting trading venues. Although standard equilibrium and asset pricing models of financial markets assume that a trader’s demand for each asset is contingent on the prices of all traded assets, this is rarely the case in practice. The paper presented in this Research Seminar examines the design of multi-asset trading algorithms. The authors compare the equilibrium and welfare effects of innovation of new synthetic products with new market-clearing technology — independent vs. joint clearing of the corresponding underlying assets. Neither instrument can reproduce the other’s welfare effects; either one may dominate in welfare terms. When traders have price impact, innovation in market clearing makes additional synthetic products nonredundant.